W HAT IS LOGISTICS ? Logistics is the design and administration of - - PowerPoint PPT Presentation

LOGISTICS & EOQ MODEL

PROFESSOR DAVID GILLEN (UNIVERSITY OF BRITISH COLUMBIA) & PROFESSOR BENNY MANTIN (UNIVERSITY OF WATERLOO)

Logistic Management in Air Transport Module 11-12 20 December 2014 Istanbul Technical University Air Transportation Management M.Sc. Program

LOGISTICS

Learning Objectives

– Key components of logistics

• Order Processing, Inventory, Transportation, Sourcing,

Warehousing, Materials Handling, and Packaging, integrated through a network of facilities (warehouses and distribution centers)

– Logistics is integral to a firm’s strategy – Keys to managing logistics costs

• Inventory management
• Transportation management

– Supply Chain Flexibility and Synchronization

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WHAT IS LOGISTICS?

• Logistics is the design and administration of systems

to control movement and spatial positioning of factor inputs (raw materials, labor, capital, energy) work- in-process, and finished inventories at the lowest total cost.

• Our focus will be on inventory management and transportation

management

THE FIVE FUNCTIONS OF LOGISTICAL WORK ARE

INTERRELATED

WHAT DO WE KNOW ABOUT TURKEY

• 81 provinces
• Bordering countries: Armenia, Azerbaijan, Bulgaria, Georgia, Greece, Iran, Iraq,

Syria

• Population (January 2013) 74.6 million (18th largest in the world)
• Urbanization: about 72 %
• Age structure: 0–14 years (26.0%); 15–64 years: (67.9%); 65 and above (6.1%)
• Nominal GDP (2012) US$790.5b
• GDP per capita (US$ current prices) (2012) - US$10,595.2
• GDP Composition: Agriculture (9.1%); Industry (27.9%); Services (63.0%)
• Public debt: 40.4 % of GDP
• Labor force (2012): 26.5 million

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GEOGRAPHIC STRENGTH

INTERNATIONAL FREIGHT-MODAL SPLIT

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GROWTH IN LOGISTICS ACTIVITIES

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CARE IN COMPARING LOGISTICS COSTS

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Year Nominal GDP ($T) Inventory Cost Transportation Cost Administrative Cost Total Logistics Cost Logistics % of GDP

1980 2.80 220 214 17 451 16.1 1985 4.22 227 274 20 521 12.3 1990 5.80 283 351 25 659 11.4 1995 7.40 302 441 30 773 10.4 2000 9.82 374 594 39 1007 10.3 2005 12.43 395 739 46 1180 9.5 2010 14.60 396 769 47 1212 8.3

U.S. LOGISTICS COST, 1980-2010 IN FIVE YEAR INTERVALS ($B)

THE COST OF LOGISTICS

LOGISTICS COSTS CANADA-U.S. COMPARISON

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INVENTORY TURNS 2007 CANADA

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LOGISTICS WILL CONTINUE ITS RENAISSANCE IN THE FUTURE

• Information technologies will automate many of the

traditionally manual logistical functions: – Automated port and rail operations – RFID tagging of materials – Advanced technologies for warehousing and inventory

• perations
• Removal of trade barriers will continue to expand global trade

and logistics

• Outsourcing versus near-shoring

– Implications for airlines?

• Logistical value proposition consists of a commitment to

key customer expectations and requirements at a minimum cost

• The two elements of this value proposition are Service and

Cost Minimization

– Firms must make appropriate tradeoffs between service and cost for each of their key customers

LOGISTICAL VALUE PROPOSITION-MANUFACTURING & SERVICE INDUSTRIES

• Availability involves having inventory to consistently meet

customer material or product requirements

• Operational performance deals with the time required to

deliver a customer’s order

– Key metrics for this area involve delivery speed and consistency

• Service reliability involves the quality attributes of logistics

– Key to quality is accurate measurement of availability and operational performance over time

SERVICE BENEFITS ARE CREATED BY LOGISTICAL

PERFORMANCE IN 3 AREAS

COST MINIMIZATION USING THE

TOTAL COST LOGISTICS MODEL

• Focused on achieving the lowest

possible cost for each individual function of logistics

– For example, Transport the material the cheapest way possible

• Expected lowest cost based on

decisions that were cheapest for individual functions

• Ignored the impact of cost

decisions across logistics functions

• Focused on achieving the lowest

total cost across each function of logistics

• A cost decision in one function

should consider impact to costs of all other logistics functions

– For example, Transporting material the cheapest way is slower than other choices. This requires an increase in storage cost to hold the material longer – Would it still be a lower cost to use the cheapest mode of transport?

Traditional Cost Logistics Model Total Cost Logistics Model

DIFFERENT PERSPECTIVES ON COST MINIMIZATION

Minimize order processing cost + Minimize inventory cost + Minimize transportation cost + Minimize warehousing, materials handling and packaging cost + Minimize facility cost __________________________ Lowest logistics cost Minimize (order processing + inventory + transportation + warehousing, materials handling and packaging + facility) cost _________________________ Lowest total logistics cost Traditional Cost Logistics Model Total Cost Logistics Model

FRAMEWORK: TOTAL LOGISTICS COST FUNCTION

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COMPONENTS OF TLC

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TLC (Q, r: T, ST) = RDi + (UCTDi/365) + (SDi/Q) + (QCI/2) + rIC + K(Di/Q) N(Z)S1 where: TLC = total logistics cost R = Transportation Rate per Unit between Origin and Destination D = Annual Demand for some good ‘i’ U = Carrying Cost of In-transit Inventory C = Value per Unit T = Transit Time of Transportation Alternative S = Fixed Ordering Cost per Order Q = Order Quantity I = Carrying Cost of Warehoused Inventory r = Safety Stock K = Stockout Cost per Unit N(Z) = Unit Loss Integral S1 = Standard Deviation of Demand During Transit Time ST = Standard Deviation of Demand During Lead Time

HOW THESE COSTS ARE DISTRIBUTED

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Cost Conflicts: Speed versus Service Reliability

23 Cost of transportation service Inventory cost (includes storage and intransit Total cost Rail Truck Air Cost, in dollars Transportation service (greater speed and dependability)

OTHER COST CONFLICTS/TRADEOFFS

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Improved customer service 100% (a) Setting the customer service level Cost Lost sales cost Transportation,

• rder processing,

and inventory costs Total costs Increasing number of stocking points (b) Determining the number of warehouses in a logistics system Cost Transportation costs Total costs Inventory costs Revenue Revenue Average inventory level (c) Setting safety stock levels Lost sales cost Total costs Inventory carrying costs Cost Product run length and product sequencing altenatives (d) Setting the sequence of production runs for multiple products Production costs Total costs Cost Inventory carryng cost

• Transportation is the operational area that geographically

moves and positions inventory

• There are three basic ways to satisfy transportation requirements

– Operate a private fleet of equipment – Contract with dedicated transport specialists – Engage carriers that provide different transportation services as needed on a per shipment basis

TRANSPORTATION

MEASURING COSTS

Cost Structure

• Costs vary with factor prices,

productivity & output

• Scale economies
• Scope economies
• Utilization economies
• Density economies
• Agglomeration economies
• Value of time/reliability

Accounting Costs

• Variable costs

– Material – Manufacturing/production – shipping

• Fixed costs

– Contracts – Capital – Manufacturing/production

• Ownership

– Purchase – Acquisition – Usage – salvage

• Opportunity cost-forgone sales

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THE SCOPE OF INTEGRATED LOGISTICAL OPERATIONS

 Responsiveness  Variance reduction  Inventory reduction  Shipment consolidation  Quality  Life cycle support

LOGISTICAL INTEGRATION REQUIRES ACHIEVING SIX

OBJECTIVES SIMULTANEOUSLY

• The customer-specified delivery facility might be near a

point of equal logistics cost or equal delivery time from two different logistics facilities

• The size of a customer’s order creates improved logistical

efficiency if serviced through an alternative channel arrangement

• Decision to use a selective inventory stocking strategy
• Agreements between firms to move selected shipments
• utside the established echeloned or direct arrangements

EXAMPLE SITUATIONS FOR FLEXIBLE LOGISTICS

STRUCTURE

SUPPLY CHAIN SYNCHRONIZATION

• Supply chain

synchronization is the

• perational integration of

multiple firms across a supply chain

– Seeks to coordinate the flow

• f materials, products and

information between supply chain partners to reduce duplication of effort – Seeks to reengineer internal

• perations of individual firms

to leverage overall supply chain capability

• The performance cycle represents elements of work

necessary to complete the logistics related to customer accommodation, manufacturing or procurement

• A performance cycle consists of the following elements

– Nodes – Links – Inventory

• Base stock
• Safety stock

– Input and output requirements

THE LOGISTICS PERFORMANCE CYCLE IS THE BASIC UNIT

OF SUPPLY CHAIN DESIGN AND OPERATIONAL CONTROL

• Major objective of logistics in all areas is to reduce

performance cycle uncertainty

• Operational variance is randomly introduced during the cycle

through

– The structure of the performance cycle itself – Operating conditions – The quality of logistical operations

PERFORMANCE CYCLE UNCERTAINTY

TOTAL TIME TO COMPLETE THE CUSTOMER DELIVERY CYCLE IS

BASED ON EACH TASK WITHIN THE CYCLE

Figure 2.8 Performance Cycle Uncertainty

INVENTORY MANAGEMENT

THE ECONOMIC ORDER QUANTITY MODEL

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Knowing what you've got, Knowing what you need, Knowing what you can live without – That’s inventory control.

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Frank Wheeler, Revolutionary

INVENTORY

• Definition: The stock of any item or resource used in an
• rganization

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Work-In-Process Raw Materials & Component Parts Finished Products Replacement parts, tools & supplies Goods in transit to warehouses or customers

IMPORTANCE OF INVENTORY:2013 FISCAL YEAR

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Wall Mart Boeing General Motors Airbus

Toyota

(Million $) (Million $) (Million $) (Million $) (Million $) Cash & Short- Term Investments 25,591 15,258 20,021 7,765

18,270

Account Receivable 6,768 6,546 8,535 7,239

54,514

Inventories 43,803 73.10% 42,912 65.90% 14,039 17.20% 25,060 53.30%

18,243 12.40%

Other Current Assets 5,987 1,500 1,662 1,653

6,059

Total Current Assets 59,940 100% 65,074 100% 81,501 100% 47,098 100%

146,570 100%

Other Assets 5,987 505 2,352 5.4 Total Assets 203,105 92,663 166,344 93,311

377,281

IMPORTANCE OF INVENTORY MANAGEMENT

• ... by 1990 Wal-Mart was already winning an important

technological war that other discounters did not seem to know was on. “Wal-Mart has the most advanced inventory technology in the business and they have invested billions in it”. (New York Times, Nov. 95)

• Kmart increased its inventories to $8.3 billions in the third

quarter of 2001 with an expectation of more shoppers. “But higher sales never materialized, leading to a disastrous holiday selling season.” Kmart filed for bankruptcy on Jan. 22. (Business Week, Mar. 02)

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IMPORTANCE OF INVENTORY MANAGEMENT MORE RECENT NEWS

• SanDisk suspends production as inventories pile up for

makers of computers, cell phones, and TVs … (Business Week, Dec. 08)

• Natural-gas futures soared 15% Thursday after U.S. inventory

data slightly eased concerns about the possibility of a storage glut (Wall Street Journal, Sept. 11, 09)

• Fruit growers were blessed with excellent weather this year.

But that hasn’t translated into a great year for the province’s cherry and blueberry growers, as a bumper crop has flooded the market and pushed down prices. (The Vancouver Sun, Aug. 09)

• The Ford assembly plant in Oakville and 3,000 workers will

remain idle this week because of a parts shortage from a supplier in India. (Toronto Star, Oct. 27, 09)

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Why do you have these inventories? What are some of the inventories that you have? WHY SHOULD YOU HOLD INVENTORY?

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Predictable Variability

Seasonal Inventories

Unpredictable Variability

Safety Stock

Economies of Scale

Cycle Stock

Transportation times / Flow times

Pipeline Inventories

Other: Strategic / Speculative / etc.

WHY SHOULD YOU NOT HOLD INVENTORY?

• Inventory increases certain costs such as

– Carrying cost – Cost of customer responsiveness – Cost of diluted return on investment – Large-lot quality cost – Cost of production problems, etc.

• The Sea of Inventory

Inventory hides problems …

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REDUCING WASTE THE SEA OF INVENTORY

HOW MUCH INVENTORY SHOULD YOU HOLD?

• Trade-off #1

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Inventory ordering costs (Economies of scale) Inventory holding costs

• Trade-off #2

Cost of running out Cost of having excess inventory

INVENTORY COSTS

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• Fixed transportation Cost
• Order Processing Cost

Ordering/Setup Costs (Fixed Costs)

• Costs for storage, handling, insurance,

working capital tied-up, etc

Holding Cost (Carrying Cost)

• Lost sales, etc

Shortage Cost (Opportunity Cost)

INVENTORY CLASSIFICATION

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Type A Items

• Small group of high volume items
• Accounts for 15% by the number of parts, and 70-80% of

the total sales of all parts

Type B Items

• Accounts for 35% of the number of parts, and 10-15% of

the total value

Type C Items

• Accounts for 50% of the total number of parts, and for 5-10% of the

total value

(The above percentages are approximate)

A classification to help manage inventories better

MOTIVATION: ATM

• How much cash do you take out from ATM?
• Why not more or less?

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ECONOMIC ORDER QUANTITY (EOQ)

• The Economic Order Quantity (EOQ) balances

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• Assumptions

– Known annual demand, constant demand rate – No uncertainty

Inventory ordering costs (Economies of scale) Inventory holding costs

NOTATION

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D Annual Demand Rate Q Lot or batch size S Set-up cost per lot/batch, or average cost of processing/placing an order C Unit cost H Annual holding and storage cost per unit of average inventory i Percent carrying cost (e.g., “interest” rate)

Usually, H = iC.

CYCLE STOCKS: TRADEOFF BETWEEN FIXED COSTS

AND HOLDING COSTS

Profile of Inventory Level over Time

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Quantity

• n hand

Q

Receive

• rder

Receive

• rder

Receive

• rder

Demand rate

Time

Example: “The South Face”

• Some facts about The South Face retail shop

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• What order size (Q) would you recommend for

The South Face?

D

Annual Demand Rate

1200 jackets/year S

Set-up cost per lot/batch, or average cost of processing/placing an order

$2,000 C

Unit cost

$200 per jacket i

Percent carrying cost (e.g., interest rate)

25%

Warehouse Retailer Customers

Thus, H = iC = (0.25)*($200) = $50 per unit-year

THE SOUTH FACE

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Q

Time t

Inventory Profile:

# of jackets in inventory over time. D = Demand rate Inventory

D Annual Demand Q Lot or batch size (Number of jackets per replenishment order)

Number of orders per year D/Q Average inventory Q/2

Annual Setup Cost (D/Q) * S Annual Holding Cost (Q/2) * H Annual Total Cost Annual Setup Cost + Holding Cost

S

Order or setup cost

H

Annual Holding cost

??? ??? Q/2

5000 10000 15000 20000 25000 30000 110 130 150 170 190 210 230 250 270 290 310 330 350 370 390 410 430 450 470 490 510 530 550 570 590 610 630 650 670 690 710 730 750 770 790 810 830 850 870 890 910 930 950 970 990

EOQ Model: Cost

Setup Cost Holding Cost Total Cost

THE SOUTH FACE: COST

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Per Order/Batch Q Batches per Year D/Q Annual Setup Cost Annual Holding Cost Annual Total Cost 50 24.0 48000 1250 49250 100 12.0 24000 2500 26500 150 8.0 16000 3750 19750 200 6.0 12000 5000 17000 250 4.8 9600 6250 15850 260 4.6 9231 6500 15731 270 4.4 8889 6750 15639 280 4.3 8571 7000 15571 290 4.1 8276 7250 15526 300 4.0 8000 7500 15500 310 3.9 7742 7750 15492 320 3.8 7500 8000 15500 330 3.6 7273 8250 15523 340 3.5 7059 8500 15559 350 3.4 6857 8750 15607 400 3.0 6000 10000 16000 500 2.4 4800 12500 17300 600 2.0 4000 15000 19000 700 1.7 3429 17500 20929

COST MINIMIZATION GOAL

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S Q D H Q TC   2

Ordering Costs

S Q D

Inventory holding cost

H Q 2

Order Quantity (Q) Annual Cost QO (optimal order quantity) Lowest Annual Cost

Total Cost

ECONOMIC ORDER QUANTITY

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S Q D H Q Q TC   2 ) ( TotalCost

D Annual Demand Rate S Order or Setup Cost H Annual Holding Cost

H SD QOPT 2 

ECONOMIC ORDER QUANTITY:THE SOUTH FACE

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D 1200 jackets/year S $2,000 H $50 per unit-year

H SD QOPT 2 

• What is the optimal order quantity?
• How many times would you place orders per year, i.e.,

frequency of ordering?

• What is the time duration between successive orders (this is

also called the cycle time or reorder interval)?

8 . 309 50 ) 1200 )( 2000 ( 2 2    H SD QOPT

8 . 3 8 . 309 1200  

OPT

Q D 258 . 1200 8 . 309   D QOPT

EOQ AND SENSITIVITY ANALYSIS

• What happens to the cost and optimal

quantity as the parameters change?

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H SD QOPT 2 

As …. “Cost” EOQ Frequency S ↑ ↑ ↑ ↓ H↑ ↑ ↓ ↑ D↑ ↑ ↑ ↑

MANAGERIAL IMPLICATIONS OF EOQ

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5000 10000 15000 20000 25000 30000 110 130 150 170 190 210 230 250 270 290 310 330 350 370 390 410 430 450 470 490 510 530 550 570 590 610 630 650 670 690 710 730 750 770 790 810 830 850 870 890 910 930 950 970 990

EOQ Model: Cost

Setup Cost Holding Cost Total Cost

• Cost curve is almost “flat” near the optimal point

– Use the EOQ formula, but do not worry about making minor adjustment to get a number that is “more realistic” for your

• rganization
• The flatness of the cost curve implies that the EOQ figure is

“robust”

– Estimating holding cost is usually difficult – The EOQ formula guarantees that the “optimal” order quantity is not very sensitive to errors in estimation

MANAGERIAL CHALLENGES HOW TO ESTIMATE COSTS?

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Ordering/Setup Costs (Fixed Costs): S

• Estimate costs incurred during the start of each new order
• Do not count “sunk” costs and fixed overhead

Unit Cost: C

• Estimate variable cost incurred in the production of each additional unit

Holding or Carrying Costs (as % of unit cost): i

• Estimate opportunity cost of working capital
• Estimate cost of storage, handling, etc

MANAGERIAL CHALLENGES HOW TO REDUCE THE EOQ INVENTORY?

• Reduce the set-up cost
• Re-evaluate sources of fixed costs, and

find ways to reduce, spread-out, or eliminate these costs

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H SD QOPT 2 

EXTRA SLIDES

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PRICING

• Concept to ‘Willingness to Pay’
• Unit cost or average cost pricing
• Cost plus pricing
• Incremental cost pricing
• Differential Pricing (special case of Ramsey pricing)
• Non-linear pricing and two-part tariffs
• Bundling and unbundling

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CONTENTS

• I. INTEGRATED LOGISTICS MANAGEMENT
• Ia. The Growth of Logistics and Its Role in the Economy
• A. What is Logistics?
• B. History of Logistics
• C. Role of Logistics in the Economy
• D. Why Logistics is gaining in importance
• Ib. The Integrated Logistics Management Concept
• A. Definition
• B. Logistics is concerned with questions about inventories
• D. Strategic profit analysis
• Ic. Logistics As An Element of Corporate Strategy
• A. A Few Logistics Facts
• B. Corporate Leverage From Logisitics
• C. Product Strategy: Innovation Phase
• D. Product Strategy: Cost Leadership Phase
• E. Product Line (Customer Service) Strategies

CONTENTS

• Id. Distribution Channels
• A. Channels: Definition, Types, Functions
• B. Integrated Channel Concept
• C. Some Logistical Implications
• Ie. Customer Service
• A. Defining Customer Service
• B. Measuring Customer Service
• C. Relationship of Customer Service to Marketing
• D. Optimizing Customer Service
• E. Stockouts
• F. Stockout Costs
• G. ABC Analysis
• If. International Logistics
• A. Importance of International Logistics
• B. International Strategies
• C. Some Additional Considerations

CONTENTS

• II. LOGISTICS SYSTEM ELEMENTS
• IIa. Inventory Management - Introduction
• A. Financial Impact
• B. Reasons for Holding Inventory
• C. Types of Inventory
• D. Example of Financial Impact
• IIb. Inventory - Carrying Costs
• A. General
• B. Capital Costs
• C. Other Costs
• D. Annual Inventory Costs
• E. Valuing Inventory (i.e. Value on Balance Sheet)
• F. Why Inventory Costs are Often Misstated
• IIc. Inventory - Management Under Certainty (EOQ)
• A. Basic Inventory Cycle
• B. Ordering Costs
• C. Effect of Decrease in Cycle Time
• D. Total Costs
• E. Optimum Quantity to Order
• F. Quantity Discounts
• G. Other Cases

CONTENTS

• IId. Inventory - Uncertainty
• A. Calculating Safety Stocks
• B. Example of Safety Stock Calculations
• C. The Flip Side: Reducing Cycle Variability for Your Customers
• D. Appendix Derivation of Formula for σc
• IIe. Inventory - Control
• A. Stock Control Methods
• B. Inventory System Design
• C. Fixed Order Point
• D. Fixed Order Interval
• E. Transport Choice Case

F. Items covered in readings, not in lectures G. Postscript: Inventory, Production, Marketing, Finance

• IIf. International Shipping
• A. Importance

B. Technology C. Demand - Shippers (Two main market segments) D. Supply - Shipping Carriers/Owners E. Freight Rates

CONTENTS

• IIg. Transport - Modes and Service Characteristics
• A. Mode Characteristics
• B. Costs
• C. Rate-Service Tradeoff
• IIh. Transportation: Consolidation
• A. Types of Consolidators
• B. Reasons for Consolidation
• C. Types of Consolidation
• D. Typical LTL Routing
• E. Containers
• IIi. Transportation: Traffic Management
• A. Traffic Management Functions
• B. Deregulation
• C. Negotiations
• D. Private Versus Public Carriage

CONTENTS

• IIj. Warehousing
• A. Functions of Warehousing
• B. Types of Warehouses
• C. Optimal Number of Warehouses
• D. Optimal Size of Warehouse
• E. Stock Location Methods
• F. Order Picking Design
• G. Public versus Private Warehouse Choice
• H. A Note on Warehouse Costs
• IIk. Facility Location
• A. Two Types of Locational Decisions
• B. Transport Cost Models
• C. Other Locational Decisions
• D. Tactical Location Considerations

CONTENTS

• IIl. Packaging
• A. The Two Functions of Packaging

B. Unitization C. Packaging Materials

• D. Some Packaging Problems/Solutions
• E. Where/When Should Packaging Be Added?
• IIm. Purchasing
• A. Introduction
• B. Forward Buying
• C. Other Aspects of Purchasing
• IIn. Materials Management
• A. Introduction
• B. Materials Requirement Planning (MRP)
• C. Manufacturing Resource Planning (MRP II)

CONTENTS

• IIo. Total Quality Management
• A. Introduction
• B. TQM versus Traditional Approach
• C. Employee motivation
• D. Examples
• IIp. Just-in-Time Systems
• A. Just-In-Time-System
• B. Manufacturing Resource Productivity (MRP III)
• IIq. Production Systems
• IIr. Distribution Requirements Planning
• A. Distribution Requirements Planning (DRP)
• IIs. Order Processing
• A. The Order Cycle
• B. The Order Processing System
• C. Impact on Logistics
• D. Implications of Advanced Order Processing Systems