Tools: Tradeoff Analysis

As you consider the many movement, storage, and processing decisions you need to make to meet customers’ needs, it is clear that you must manage many tradeoffs to design and manage a high-performing logistics network. However, improving service almost always costs money. The closer you get to 100% perfection, the more quickly the costs of service improvements rise. Because you must pay more for better service, you need to consciously think about “tradeoffs.” Ask, "What service characteristics are most important to our customers? How can we achieve as many of these as possible?" Never forget your goal: Meet customers’ needs AND make money.

We now discuss some classic tradeoffs that you face as you strive to improve your in-stock levels, speed delivery to customers, and improve your overall reliability. Figure 1.9 shows the tradeoff between inventory levels and lost sales. In general, as you increase the level of inventory you carry, you are able to reduce lost sales. You have the stock on hand to meet more customers’ needs—even if those needs are unpredictable. The greater the unpredictability or variability of customers' needs, the more stock you need on hand to meet customers' service level requirements. At some point, your total cost may rise so much that it simply does not make sense to meet everyone’s potential needs.

Figure 1.9: The Relationship between Cost of Lost Sales and Inventory Cost

Figure 1.10 illustrates a similar tradeoff between transportation costs and lost sales. Faster, more reliable transportation is generally more expensive. If you are willing to ship everything by air—flying products directly to your customers—you can almost always meet your customers’ delivery needs (wherever they are located worldwide). But, airfreight is very expensive (up to 10-12 times other transportation options). Few customers are willing to pay the higher costs. Most companies give customers the choice of what kind of transportation they would like to use, but the customer has to be willing to pay for it. For example, if you place a $50 order with REI, an outfitter of outdoors gear, by phone or online, they give the following shipping options:

  • Free shipping that arrives within 5 days

  • 2-day shipping for $24.99

  • 1-day shipping for 32.99

Free is always a popular price. But, if you are leaving for a camping trip in the beautiful, but rainy Redwoods National Park in northern California, USA and have just discovered that your tent has a leak, you might choose the one-day option to have the tent delivered to the Ranger. You might even consider that shipping cost a bargain!

Figure 1.10: The Relationship between Cost of Lost Sales and Transportation Cost

Another classic set of tradeoffs exists among product value and inventory cost, transportation cost, and packaging cost (see Figure 1.11). In all cases, as the value of a product goes up, the costs associated with logistics for the product naturally increases. Consider the following relationships:

  1. Inventory Costs: Inventory costs go up because more dollars are tied up in inventory, insurance costs will be higher, more security is needed, and the loss is higher if something negative does occur.

  2. Transportation Costs: Transportation costs increase for many of the same reasons, plus you may want to use more expensive modes to get the product where it is going faster—to close a sale and free up cash faster.

  3. Packaging Costs: Packaging costs also increase, primarily because you want to protect the product from loss, damage, or pilferage to a greater extent due to the greater potential loss. You may even want to use packaging to disguise a product. Warehouses that are known to store items like tobacco products, liquor, and guns are generally protected by armed guards, include tight security for entry, house products in locked cages, and are often behind barriers so that those entering the warehouse cannot see exactly what is being stored.

Figure 1.11: Tradeoffs Associated with Product Value

Similarly, as a product’s susceptibility to loss or damage increases, so does the cost of the packaging, transportation, and warehousing to keep it safe from damage, spoilage or theft (see Figure 1.12). These increased logistics costs apply to fragile or perishable products. For example, eggs are shipped with multiple layers of protective packaging. Further, they must be shipped and stored in expensive climate-controlled conditions and cannot use slower, cheaper modes like water and rail due to the time these modes take as well as the bumpier transport conditions. “Trendy” products that can easily be sold on the black market may require electronic tracking or extra packaging to disguise their identity so that they won’t be pilfered.

Figure 1.12: Tradeoffs Associated with Product Susceptibility to Loss or Damage

Finally, costs vary based on product density (see Figure 1.13). The weight density of a product refers to how much space a product takes up versus how much it weighs. The space that a product takes up is also often referred to as its cube. Because of government regulations and standardized trailer sizes, an efficient cube is a load that fills up a 20-foot trailer (also referred to as TEU or twenty-foot equivalent unit) when it weighs about 40,000 lbs. In other words, a tradeoff exists between “weight” and “cube.” Light products like tortilla chips will cube out (fill the trailer) long before they weigh out (i.e., hit the imposed weight limit for a trailer). Heavy products like liquid laundry detergent or beer will weigh out before they cube out. The goal with the latter is to reduce as much non-product weight as possible—such as packaging—in order to fit the most product value on a truck. As companies have reduced the weight of packaging used and moved from packing products in cartons to shrink wrap with just a cardboard base, they have been able to reduce weight and add more product to a trailer. This is a simple practice companies use to reduce the impact of classic tradeoffs on cost and service levels.

Figure 1.13: Tradeoffs Associated with Product Weight Density

The bottom line: Tradeoffs are everywhere. Your challenge is to identify them, evaluate them, and then try to systematically balance them to achieve the right service/cost equation to meet customer needs. To help you do this, we next discuss lean processes that can help beat the tradeoffs.

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