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Logistics: What Buyers Must Know

Author(s):

Mark S. Miller, C.P.M.
Mark S. Miller, C.P.M., Purchasing Manager, CASE CORPORATION, 700 State St., Racine, WI 53404, (414)636-6565.
James P. Weber, C.P.M.
James P. Weber, C.P.M., Team Purchasing Manager, CASE CORPORATION, 700 State St., Racine, WI 53404, (414)636-6656.

80th Annual International Conference Proceedings - 1995 - Anaheim, California

Logistics is often considered a function of the traffic department. Recently it has been recognized that purchasing plays a critical role in logistics. NAPM (National Association of Purchasing Management) selected as the theme for the 1993 International Purchasing Conference "Logistics: Navigating The Future.,, We will discuss the basics buyers should know about logistics and three important areas in which purchasing can help reduce the cost of logistics.

Logistics Basics. Logistics is the study of all the activities involved in the cycle of getting the product to the right place at the right time. All movement of product in the pipeline should be considered: the raw material movement from the supplier to the plant, processing at the plant, warehousing and packaging, traffic movements between locations, the distributor and delivery to the customer. The Council Of Logistics Management defines logistics as:
...The process of planning, implementation, and controlling the cost-effective flow and storage of raw materials, in-process inventory, finished goods, and related information from point of origin to point of consumption for the purpose of conforming to customer requirements ...

The key focus of logistics is measuring the cycle time speed of each element in the pipeline and the cost trade-offs involved. Management is recognizing the importance of logistics, because of the profit opportunities that exist. Logistics in the United States are estimated to cost $375 billion, or 8% of the average company's sales (source: Cass Logistics). These costs broken down into categories are:

  • 32% - Inventory carrying costs
  • 23% - Transportation costs
  • 20% - Warehouse costs
  • 18% - Order processing costs
  • 7% - Administration costs

Now we will review, three major areas of logistics in which a buyer plays an important role: reducing cycle times, establishing third party logistics partners, and establishing in-house supplier personnel.

Purchasing and Cycle Time Reduction. The definition of cycle time is: "The elapsed time between the beginning and completion of a task." The definition seems simple; but the reduction of cycle time is a main priority for purchasing professionals today. In the 180's , the main driving force was quality; in the 190's it is quality plus speed. Customer expectations continue to rise, and service levels must rise to meet these expectations. Today, customers are demanding that we eliminate all non- value added cycle time. working with suppliers, purchasing can dramatically reduce cycle times in two areas: reducing leadtimes and improving on time delivery performance.

  1. Reducing Leadtimes. Leadtime reductions allow for carrying less backup inventory and at the same time providing superior customer service despite forecast changes, unusual demand or pipeline disruptions. Lower leadtimes translate into less inventory and therefore reduced logistics costs.

    One method we've found that successfully reduces leadtimes is to offer the supplier a tradeoff. The supplier reduces leadtimes through efforts to improve his processes or by simply carrying more backup inventory for us. In exchange we will negotiate firm volumes guarantees so the supplier doesn't risk eating the extra stock.

    Another strategy we've used is to work with suppliers to reduce order entry cycle time. we found we were only releasing schedules to suppliers once a month and mailing the documents. By switching to weekly releases and establishing electronic links with suppliers, we reduced our order entry leadtimes by almost a month.
  2. Improving Supplier On Time Delivery. Another way to speed up the efficiency of the logistics pipeline is to improve supplier on time delivery. As a result of poor supplier delivery (as low as 50% late in 1991), we were carrying a large amount of safety stock inventory in order to keep the production line running and to maintain acceptable service levels to our customers.

An investigation of the root causes of our poor supplier delivery showed that many of the problems were being caused by us--not the suppliers:

  • Suppliers didn't understand our schedule documents
  • We were making too many schedule changes
  • Suppliers weren't aware of our delivery requirements.

Purchasing worked closely with suppliers to improve delivery performance. We held meetings and explained our expected delivery requirements (three days early to the due date). We walked suppliers through our scheduling documents and made sure the people who were processing the forms understood them. Improvements were made to our forecasting and scheduling system which reduced the number of short lead time schedule changes we requested.

On time delivery has become a key supplier rating factor. It has also become a key performance measurement for our buyers. Buyers are rated on major supplier performance, starting each year with a benchmark for each supplier, with a goal of continuous improvement throughout the year. Each month a letter is sent to the supplier's management reviewing, in detail, the previous month's delivery performance. Finally, awards are given annually to recognize suppliers who have maintained superior delivery performance for the past year.

Establishing Third Party Logistics Partners. Many firms have found that major cost reductions and cycle time improvements can be achieved by outsourcing nonprimary operations to third party logistics firms. It is estimated that $10 billion of logistics (2.5%) is currently outsourced (source: Cass Logistics), but logistics outsourcing is increasing at a rate of 10* a year. Among the activities often resourced are: traffic management, expediting, warehousing, receiving, inspection and inventory management. We are currently using a third party to handle our receiving, line filling, some inspection, packaging, painting and running five of our part warehouses. We have found there are several advantages to using third party firms:

  1. Concentrate on Primary Business. Companies are integrating resources to focus on key products, manufacturing processes and markets. Logistics is one area that is a noncore operation to most companies, and therefore is a prime candidate to be outsourced. Most companies realize that they do not want to invest substantial resources in noncore operations.
  2. Expertise. The major third party logistics firms are experienced experts in logistics. It is their core business. They have developed systems and transportation networks that private companies cannot afford to duplicate. They can also share the newest and best ideas that have worked with other customers.
  3. Flexibility. By outsourcing to a third party the logistics operation overhead moves from a fixed cost to a variable cost. A third party can flex the work force and warehouse space with other customers to react to peaks and valleys of volume changes. Third parties can use part time and contract labor so labor costs are often times much less.
  4. Cycle time improvements. The third party firm can help to improve the velocity of moving goods to the customer. These improvements in cycle time will help replace inventory with information.
  5. Avoid Capital Costs. A third party firm can arrange for warehouse space, furnish equipment, have computer hardware and software used that doesn't require an up front capital investment from your company. A big advantage of outsourcing is that instead of capital that is fixed cost, they turn into variable costs that can be raised or lowered upon demand.

In most companies there is a general reluctance to consider using a third party logistics company. This reluctance stems from among the following reasons:

  • Loss of Control - Any function that is outsourced means some level of control is lost.
  • Uncertainty of Third Party Capabilities- The third party firm is an unknown entity and thus will cause uncertainty.
  • Fear of Job Loss - outsourcing usually causes a reduction of head count and a resulting fear of job loss.
  • Admitting Internal Incompetence - Too often outsourcing is associated with internal failure to adequately perform the function internally.
  • Resistance to Change - Any major change within an organization causes a natural resistance that must be overcome.

Selection of the right third party firm should help resolve these issues. Following are the areas that purchasing should investigate when selecting a third party logistics source:

  • Financial Stability - one of the major benefits of a third party logistics firm is investing in capital and systems components. Purchasing must insure the third party firm has the financial resources to make required investments.
  • Information Management System - A third party firm is usually depended on to build system interfaces to your system, put in RF bar coding and use Electronic Data Interchange. The suppliers system department is critical
  • Experience - You are looking for a firm who has expertise your firm does not have--and this comes from experience.
  • Customer References - Talking to other existing customers is the quickest way to analyze a potential third party firm.
  • Customer Service Commitment - Purchasing should investigate (by customer references) the supplier's customer service commitment. Once the source has been selected, the contract purchasing negotiates with the third party should include:
    1. Cost Structure. A clear understanding of how costs and prices will be established is a key factor for purchasing. We have established arrangements that include a monthly fee to cover fixed costs and a variable fee that is based on transactions processed.
    2. Termination. Both parties need to agree on the conditions under which the agreement can be terminated. Under what condition and with how much notice can the outsourcing arrangement be dissolved. If the third party firm has leased space, purchased a system, or bought equipment on your behalf, the responsibility regarding these items at termination must be agreed to.
    3. customer service/quality requirements. Benchmarks for throughput, cycle time and accuracy should be included in the contract. The type of function outsourced will dictate the appropriate customer service and quality requirements to be included.

In-house Supplier Support and Logistics. An alternative to outsourcing to improve logistics is to move supplier personnel into your office. Functions that can be performed by suppliers include: expediting, resolving quality/inspection problems, scheduling, and inbound traffic routing. When we first purposed in-house supplier support, there were many issues we had to address including: selection, confidentiality and internal issues.

  1. Selection. The first step was to establish ground rules regarding how suppliers would be selected as candidates for in-house support. We choose to limit in-house support to suppliers that had been chosen as the sole, preferred supplier for a product. This solved many of the questions that were raised regarding security. There was no longer a competitive situation that needed to be protected. We keep careful records documenting the criteria by which these suppliers had been selected. Each time the long term contract was due to expire purchasing does a new evaluation to insure the agreement should be extended.
  2. Confidentiality. We established a confidentiality agreement that we required in house supplier personnel to sign.
  3. Internal items. The hardest part of establishing in-house supplier support was selling our own management on the idea. Items such as workmen's compensation liability, office and phone availability, password security, liability, union issues, defining job functions and supervision has to be established. Each objection was addressed. In the end we eliminated duplicate resources, improved communication with suppliers and reduced our logistics costs by establishing in-house supplier support.

The advantages of having in-house supplier support are:

  • Cycle Time Improvements - With the in-house supplier personnel placing orders and expediting the normal cycle time is reduced.
  • Communication Improvement - With suppliers working next to you in your office, communications are improved.
  • Supplier ownership of Goals - We assign inventory and shortage goals to the in-house personnel.
  • Less Cost Than Permanent Employees - Functions previously performed by company personnel are now performed by suppliers.

Disadvantages:

  • Loss of Competitive Leverage - One supplier is selected for the business so competitive leverage is lost.
  • Additional Training/Supervision - In-house supplier personnel must be trained and supervised by company staff.
  • Loss of Internal Control - More internal control is involved with in-house supplier personnel than with outsourcing, but some control is still lost from when your own people were doing the function.
  • Office Space - office space is needed for in-house supplier personnel. This has been a big challenge for us.

Summary. It's important for the buyer to understand logistics and how he can directly impact logistics costs. The buyer can work with his suppliers to reduce leadtimes and improve on time delivery. Purchasing has an important role in selecting and negotiating contracts with third party logistics firms. Supplier in-house support should be investigated as another tool to reduce logistics costs. By understanding logistics and the critical part purchasing plays in it, we all have an opportunity to gain management recognition and make our companies more successful.


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