L OGİSTİCS & EOQ M ODEL P ROFESSOR D AVID G ILLEN (U NIVERSITY OF B RITISH C OLUMBIA ) & P ROFESSOR B ENNY M ANTIN (U NIVERSITY OF W ATERLOO ) Istanbul Technical University Logistic Management in Air Transport Air Transportation Management Module 11-12 M.Sc. Program 19 December 2015
L OGISTICS 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 – Sourcing – strategic vs operational approaches 2
W HAT 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
T HE FIVE FUNCTIONS OF LOGISTICAL WORK ARE INTERRELATED
G ROWTH IN L OGISTICS A CTIVITIES 5
T HE COST OF LOGISTICS
L OGISTICS 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 operations • Removal of trade barriers will continue to expand global trade and logistics • Outsourcing versus near-shoring – Implications for airlines?
C OST MINIMIZATION USING THE TOTAL COST LOGISTICS MODEL Traditional Cost Logistics Model Total Cost Logistics Model • Focused on achieving the lowest • Focused on achieving the lowest possible cost for each individual total cost across each function of function of logistics logistics – For example, Transport the • A cost decision in one function material the cheapest way should consider impact to costs of possible all other logistics functions • Expected lowest cost based on – For example, Transporting decisions that were cheapest for material the cheapest way is individual functions slower than other choices. This requires an increase in storage • Ignored the impact of cost cost to hold the material longer decisions across logistics – Would it still be a lower cost to functions use the cheapest mode of transport?
D IFFERENT PERSPECTIVES ON COST MINIMIZATION Traditional Cost Logistics Model Total Cost Logistics Model Minimize order processing cost Minimize (order processing + + inventory + transportation + warehousing, materials handling Minimize inventory cost and packaging + facility) cost + _________________________ Minimize transportation cost + Lowest total logistics cost Minimize warehousing, materials handling and packaging cost + Minimize facility cost __________________________ Lowest logistics cost
F RAMEWORK : T OTAL L OGISTICS C OST F UNCTION 10
C OMPONENTS OF TLC TLC (Q, r: T, S T ) = RD i + (UCTD i /365) + (SD i /Q) + (QCI/2) + rIC + K(D i /Q) N(Z)S 1 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 S 1 = Standard Deviation of Demand During Transit Time S T = Standard Deviation of Demand During Lead Time 11
H OW THESE C OSTS ARE D ISTRIBUTED 12
Cost Conflicts: Speed versus Service Reliability Total cost Cost, in dollars Cost of transportation Inventory cost service (includes storage and intransit Rail Truck Air Transportation service (greater speed and dependability) 13
O THER C OST C ONFLICTS /T RADEOFFS Revenue Total costs Total costs Revenue Cost Cost Transportation, order processing, Inventory and inventory costs costs Lost sales cost Transportation costs 0 0 0 0 100% Increasing number of stocking points Improved customer service (a) Setting the customer service level (b) Determining the number of warehouses in a logistics system Total costs Total costs Cost Cost Inventory Inventory carrying carryng cost costs Lost sales cost Production costs 0 0 0 Average inventory level Product run length and product sequencing altenatives (c) Setting safety stock levels (d) Setting the sequence of production runs for multiple products 14
M EASURING C OSTS Cost Structure Accounting Costs • Variable costs • Costs vary with factor prices, – Material productivity & output – Manufacturing/production • Scale economies – shipping • Scope economies • Fixed costs – Contracts • Utilization economies – Capital • Density economies – Manufacturing/production • Agglomeration economies • Ownership • Value of time/reliability – Purchase – Acquisition – Usage – salvage 15 • Opportunity cost-forgone sales
T HE SCOPE OF INTEGRATED LOGISTICAL OPERATIONS
I NVENTORY MANAGEMENT THE E CONOMIC O RDER QUANTITY MODEL 17
Knowing what you've got, Knowing what you need, Knowing what you can live without – That’s inventory control. Frank Wheeler, Revolutionary 18
I NVENTORY • Definition: The stock of any item or resource used in an organization Raw Materials & Component Parts Goods in transit to Replacement parts, Work-In-Process warehouses or tools & supplies customers Finished Products 19
I MPORTANCE OF I NVENTORY :2013 F ISCAL Y EAR Wall Mart Boeing General Motors Airbus Toyota (Million $) (Million $) (Million $) (Million $) (Million $) Cash & Short- Term 25,591 15,258 20,021 7,765 Investments 18,270 Account 6,768 6,546 8,535 7,239 Receivable 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 5,987 1,500 1,662 1,653 Assets 6,059 Total Current 59,940 100% 65,074 100% 81,501 100% 47,098 100% Assets 146,570 100% Other Assets 5,987 505 2,352 5.4 Total Assets 203,105 92,663 166,344 93,311 377,281 20
I MPORTANCE OF I NVENTORY M ANAGEMENT • ... 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 ) 21
W HY SHOULD YOU HOLD INVENTORY ? Predictable Variability Seasonal Inventories What are some of the inventories Unpredictable Variability Safety Stock that you have? Economies of Scale Cycle Stock Why do you have these Transportation times / Flow Pipeline Inventories times inventories? Other: Strategic / Speculative / etc. 22
W HY 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 … 23
R EDUCING WASTE T HE S EA OF I NVENTORY 24
H OW MUCH INVENTORY SHOULD YOU HOLD ? • Trade-off #1 Inventory ordering costs (Economies of scale) Inventory holding costs • Trade-off #2 Cost of running out Cost of having excess inventory 25
I NVENTORY C OSTS Ordering/Setup • Fixed transportation Cost Costs • Order Processing Cost (Fixed Costs) Holding Cost • Costs for storage, handling, insurance, working capital tied-up, etc (Carrying Cost) Shortage Cost • Lost sales, etc (Opportunity Cost) 26
I NVENTORY C LASSIFICATION A classification to help manage inventories better 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) 27
M OTIVATION : ATM • How much cash do you take out from ATM? • Why not more or less? 28
E CONOMIC O RDER Q UANTITY (EOQ) • The Economic Order Quantity (EOQ) balances Inventory ordering costs (Economies of scale) Inventory holding costs • Assumptions – Known annual demand, constant demand rate – No uncertainty 29
N OTATION 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. 30
C YCLE S TOCKS : T RADEOFF BETWEEN FIXED COSTS AND HOLDING COSTS Profile of Inventory Level over Time Q Demand rate Quantity on hand Time Receive Receive Receive order order order 31
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