SCM Module 3 notes

SUPPLY CHAIN MODULE 3:

Warehouse Management
Warehouses or stores play a vital role in the operations of a company. It is in direct touch with the user
department in its day-to-day activities. The most important purpose served by the stores is to provide
uninterrupted service to a construction site. Further, stores are often equated directly with money as
money is locked up in the stores.
Objectives and Functions of Stores
The simplest (and very outdated) definition of the warehouses or stores is that it is the place where one
keeps (or offloads) material for some time before its use.
According to a more functional definition of stores, it is a place where following activities are carefully
undertaken:
Receipt of goods, timely procurement of materials, accounting the transactions, minimising
obsolescence, surplus & scrap by proper identification and using correct preservation methods, ensuring
good housekeeping by accurately and timely updation, issue of receipts, ensuring issues and other
documentation and handling other issues pertaining to storage and cleanliness.
In some cases, the procurement and optimisation of inventory is also added to the functions of stores.
For example, the store’s manager may be given the additional powers to procure urgently required
items.
In other words, the functions of stores can be classified as follows:
(a) To receive raw materials, components, tools, equipment and other items and account for them,
(b) To provide adequate and proper storage and preservation to the various items,
(c) To meet the demands of the user departments by proper issues and account for the consumption,
[d) To minimise obsolescence, surplus and scrap through proper codification, preservation and
handling,
(e) To highlight stock accumulation, discrepancies and abnormal consumption and evolve effective
control measures,
(f) To ensure good housekeeping so that material handling, material preservation, stocking, receipt and
issue can be done adequately, and
(g) To assist in verification and provide supporting information for effective purchase action.

1. STORES SYSTEMS AND PROCEDURES

Broadly, the systems in stores can be studied under three areas namely, receipt, issue and
documentation. It may be seen that at every stage a great deal of information is required for checking,
controlling and feedback purposes. Well-designed stores systems and procedures ensure timely
information for decision making, particularly because stores is the starting point of all activities for
control. Let us briefly consider the systems and procedures in each area.
1.1 Management of Receipts
The inputs into stores or receipts can emanate from internal as well as external sources. The procedures
start even before the material reaches the stores when a Purchase Order (PO) is placed on the vendor.
In certain organisations, the stores and purchase activities are bifurcated, but care should be taken to
ensure close coordination.
The details should be maintained in a chronological order to enable the ease of understanding. The
scope of work involves following functions:

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(a) Requirement determination,

(b) Raising purchase requisition,
(c) Chasing purchase orders to expedite supplies,
(d) Scheduling arrival of materials,
(e) Receiving the materials physically and planning for storage,
(f) Quantity & quality inspection,
(g) Checking input documents like invoice, lorry receipt, delivery challans and other challans, invoices
etc.,
(h) Taking stock of material received and also of rejected material,
(i) Endorsing the suppliers bills and quantities and forwarding for payment to accounts, Provisional
goods inwards in case of later inspection,
(k) Final goods inwards in case of final acceptance of goods,
(1) Informing indenting departments of arrival of goods,
(m) Sending paperwork to purchase accounts for payment,
(n) Updating insurance paperwork for latest goods arrival, and
(0) In case of demurrages, arrange for insurance company visit.
All this demands a clearly laid out procedure which all concerned are informed about. In addition to
these functions, other functions are as follows:
(a) Regularise miscellaneous items like samples & cash purchases by raising receipt notes,
(b) Complete record keeping formalities for returnable items and items received from feeder shops for
later internal or external consumption,
(c) Keeping record of scrap received, and
(d) Keeping record of other bulk material supply items which may not be physically received or stored
in the warehouse, like fuel oil etc.
1.2 Issue Control
We now come to the stage namely, issues. Issues can be further divided into issues to consuming
departments, and issues to outside suppliers for processing or conversion.
In both cases, there are certain common system requirements. The first aspect is the control of issues.
Issues are based on scheduling of project. The second aspect is delegation of authority.
Here, in this unit, we are concerned only with the first aspect. The scope of this issue control involves
the issue of the right material, in the right quantity, to the right personnel, at the right time and place on
receiving the right authorisation, maintaining the records for the same.
Based on consumption schedules/production programs, listing for each material, quantity to be issued
for each project for that material is made and circulated to all concerned.
This automatically controls consumption as the work order issued details on the quantity of material to
be issued by the stores and the stores personnel are not authorised to issue beyond these quantities.
Thus, for routine work, operations get streamlined and free of bureaucracy.

The stores also keeps check on inventory and raises alarms or raises purchase orders (as the case may
be) from time to time. Care should be exercised that work is not held up for the want of materials.
One time issues like bathtubs, furniture, almirahs etc. are to be accounted for separately.
Proper weighing and counting equipment should be used for issuing bulk materials. Thus, these
instruments need to be calibrated frequently.
Provision should be made for emergency issue and procedures should be clearly defined for all
concerned to regularise this.
1.3 Stores Documentation

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All the documents received or generated inhouse should be properly categorised and a numbering
system should be developed for proper storage and quick retrieval. Besides the receipt and issue
documents, some other methods of documentation necessary are given below:
(a) Bincard or kardex,
(b) Stores transfer voucher (from one stores to another),
(c) List of slow moving/fast moving/obsolete items,
(d) Scrap disposal,
(e) Rejection notes,
(f) Acceptance notes,
(g) Delivery notes,
(h) Travel requisitions,
(i) Tour and expense reports,
(j) Impress details,
(k) Indents,
(1) Codification methodology, and
(m) Material requirement planning.

2. STOCK VALUATION AND VERIFICATION

There is a distinct difference between the two terms "valuation" and "verification".
Valuation is the monetary equivalent of the stock or material in hand whereas verification is the
determination or quantification of the material in stock and checking its deviation from the figures
shown in the books.
Valuation becomes necessary to assess the assets of the company for sale, determining insurance cover
to be taken, during acquisition and mergers, get an idea about the difference between book and actual
depreciation etc. Since the procurement price or sale price of a material does not remain constant, it is
necessary to evaluate the stocks regularly or during specific occasions. For example, if the price of an
item in inventory which is required for producing something has gone up during its storage period,
selling it by basing its selling price on the past purchase price can mean lesser margins. Similarly, if the
price has gone down during the stocking period, selling it at a higher price can mean being out priced
by competition.
Since valuation methods can increase or decrease assets, companies occasionally resort to manipulating
the valuation methods to present rosy or drastic pictures as the case may be.
For instance, the gross profit is the difference between net sales and costs of production.
Since materials cost is a part of production, the valuation basis can determine whether the company is
going to have profits or losses. Frequent unauthorised changes are illegal.
Under the companies act, a change in the method of valuation has to be approved by the Board of
Directors of the company and must be reported along with the effect of changes in the profitability due
to the changes in method of valuation duly certified by the auditors.
2.1 Methods of Valuation
The methods of valuation are many. In actual practice, there may be more than one method being
followed; one for taxation purpose and the other for control purpose. The details of some of the
important methods are given in subsequent paragraphs.

FIFO (First in First out) Method

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FIFO method assumes that material purchased are issued in strict chronological sequence, i.e. the
material which comes in first is issued first. This method ensures that the materials are issued at the
actual cost and the valuation is done at the latest price paid. So long as the cost of the material does not
fluctuate much, the assessment works fine.
The disadvantages are that in very highly fluctuating costs periods, every batch will have different costs
and the comparison between batches becomes meaningless. Moreover, in an inflationary scenario, the
time lag from the period the material is inward to that when it is issued results in the material being
issued at a lesser price than its current price which wrongly indicate the higher profits.
An illustrative example of a FIFO method is shown in Table

LIFO (Last in First out) Method

This method assumes that the material coming in last are the first to be issued. The advantage of this
method is that the costs are reckoned closest to the latest price and thus, reflecting the latest market
positions (if receipts are recent). But the stocks are still evaluated at the old prices for valuation purpose.
In times of falling prices, the LIFO system (due to lag) charges a cost to production or cost at the time
of issue, a value which is lower than the actual market price, unlike FIFO system which could have
charged a price which might be lesser/more/same depending on the price at the time of the first
purchases. Thus, while FIFO is a conservative approach and suffers from time lag, LIFO is directed at
the latest market conditions so that the pricing conditions are up-to-date as much as possible. An
illustrative example of a LIFO method is shown in Table

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Other Variations of FIFO and LIFO Methods

The variations of these methods such as HIFO (highest in first out), NIFO (next in first out) are
modifications of the FIFO and LIFO methods but are not commonly used due to the extra monitoring
work involved. Simple Average Price Method In this method, the issues are valued on the basis of a
simple average price of the inward items. The prices of purchases prior to any issues are summed and
the average is obtained by dividing by the number of purchase prices used. An example is shown below
:
Let the prices in the last three issues be 1.0, 1.1 and 1.2. Therefore, the average
(1.0+ 1.1 + 1.2) /3 price would be = 1.1
This method is simple and easy to use and gives reasonable values for not so fast varying items.
However, approximations in calculations can give rise to errors. Moreover, the variations in the past
prices may be due to the different quantities procured and thus, the discounts availed. So if the
procurement quantities are not the same. Moreover, a temporary price fluctuation, say rise in price of
cement in an area due to floods, can give erroneous results in the valuation.
Periodic Average Price Method
The lacunae of the simple average method is attempted to be overcome in this method by considering
prices for a defined large enough period to make the variations in price more uniform. The prices
considered for valuation can be the past six months, quarter or year. The problem with this method is
the extreme amount of calculations involved by referring to past records. It also suffers from the same
drawbacks as that of the simple average price, but can be easily used for batch type productions by
suitably adjusting the periods and remove the high fluctuations in prices.

Weighted Average Price Method

The variation in prices due to different quantities in the simple and periodic price methods is overcome
largely in this method. The issues to the user department are split into equal batches from each shipment
at stock. Here, the rate is arrived by dividing the total cost by the total items. This new rate is applied
for consumers. As new items are procured, the new average is computed for further issues. In actual
usage, the weighted average is derived for a given period instead of doing everytime for every issue or
procurement as this tends to be too time consuming. The weighted average method is quite popular as
it is not tiresome and gives a fairly accurate tracking of the market conditions. The values reflected in
this method do not "jerk" the balance sheets as the weighted averages prevent it.
An illustrative example of weighted average price method is shown in Table

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Standard Cost Method

In this method, a forecasted unit price for a specific period of one year or more is used to evaluate the
issues. Some of the factors taken into consideration for calculating the standard cost are as follows :
(a) Market conditions,
(b) Depreciating nature of the item,
(c) Usage rate,
(d) Storage conditions,
(e) Handling facilities,
(f) Obsolescence, and
(g) Losses in storage.
The actual cost of procurement is thus different from the standard cost, but this figure helps in providing
guidelines to purchase unit for correct buying prices and negotiating goals. In addition, this top-down
approach tries to mould the procurement and inventory department to bring in line their thinking to the
management goals. The success of computing the standard cost is thus, very important in terms of
predicting actual values. The procurement department thus, has a guideline. The smaller the gap
between the standard value and actual costs, the better the management has control over finances. If
variation exists between the standard and actual costs, the variance can be taken care of in the actual
market selling or project pricing costs. Efficient use of the materials is truly reflected as accounting is
now separated from fluctuations in rates, thus saving the manpower accounting hours.
An illustrative example of standard cost method is shown in Table

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As can be seen this method is applicable if a very strong analytical team is available to compute the
standard costs.
Replacement Price
This method is very suitable for a relatively high inflationary economy. In this method while purchases
are valued at the price paid for, the issues are valued at the price required to replace them at the current
prevalent prices. This ensures that the final product is priced at market prevalent rates.
The problem with this method is that the replacement value is not available at all times. Thus, a very
strong system to keep updated prices has to be evolved which in turn costs money. The issue material
follows market price but since the in stock material is evaluated at the actual prices, in an inflationary
economy, the stock in hand is always under evaluated. Conversely, when the prices are falling the stocks
in hand are always over evaluated leading to frequent write-offs.
The rate of depreciation or appreciation of all materials in stock is also not the same. Thus, balancing
stocks can be problematic.

2.2 Stock Verification

As mentioned earlier, the stock verification is the determination or quantification of the material in
stock and checking its deviation from the figures shown in the books. The store’s manager holds the
responsibility for all happenings in the store. He must periodically verify all stocks to reconcile the
books with the physical presence of the material. The problems mount as the number of items or the
number of transactions increase. Stock verification also checks for pilferage and shows the qualitative
upkeep of the stores. The causes for discrepancy in stock can be due to the following reasons:
(a) The scales or weighing machines etc. have not been properly calibrated or are not of good quality
or being maintained improperly,
(b) Issues without indents or proper paperwork,
(c) Delays in updating paperwork,
(d) Untrained individuals handling paperwork,
(e) Pilferage,
(f) Obsolescence,
(g) Deterioration and damage due to natural causes like corrosion, insect damage, rodent damage or
seepage of rainwater etc., and
(h) Deterioration and damage due to unnatural causes like theft, sabotage etc.

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The process of verification is the physical counting, weighing or measuring the stock of materials that
is in stock and making a record of these figures.
The persons who normally supervise these operations are responsible people from:
(a) Accounts department,
(b) Internal audit department of large companies,
(c) Sometimes, auditors from the bankers or loan givers, and
(d) .in case of mergers, the representatives of the other company.
The verification process is normally started only after a clear cut guidelines for the process is written
down and approved by the concerned authorities. To prevent overwork or stoppage of normal work for
inconvenient time periods, the verification process must be carried out over a long period switching
from one area to another. Sometimes, this is not possible and all verification has to be done at one go.
The stores personnel should be actively involved in the verification process to make it stop seem like a
witch hunt. If the discrepancy between actual figures and the book values are substantial enough ahd
not properly explicable, it is necessary to start an immediate investigation as the organisations will gain
if the stores personnel are motivated by proper development of an atmosphere of good values and quick
justice.

3. WASTE MANAGEMENT - DISPOSAL OF SURPLUS,

OBSOLETE AND SCRAP
Before going into the details of waste management, some of the important terms, i.e. surplus, obsolete
and scrap etc. need to be defined.
Surplus: These are materials which have no immediate use or at least in the foreseable future. They
have accumulated due to faulty planning, forecasting and purchasing.
Sometimes, they may have accumulated since they are standardly bought in quantities only and not in
loose form where they would be more expensive. In short, surplus stocks are the items which are in
excess of their requirement.
Obsolete Stocks: They are those items which are not damaged and have economic worth but are not
suitable for the company's specific operations. For example, the spare parts of machines that have been
phased out. Changes in product design, technological advancements, rationalisation, food and drugs
whose effectiveness has lapsed over time, wrong codification etc. are some of the reasons why
obsolescence occurs. As the name implies, they are non-moving items of the inventory.
The difference in obsolete and surplus lies in the potential for usage. Surplus items are only in excess
of what is required, obsolete items cannot be used at all.
Salvageable Items: These are items which cannot be used for the original purpose but out of which
certain parts may be removed and used either with or without rework. For example, the motor of a spoilt
air-conditioner may be used for other air-conditioners. While removing, these motors should again be
regularised as spares for inventory purpose.
Reclaimable Items: These are items which have worn out by use but their life can be extended by
some specialised processes. An example is worn out tyres which can be retreated. Before reclaiming
items, their extended life should be properly determined as sometimes reclaiming is expensive and the
extended life is not commensurate to the cost incurred.
Scrap: This is another term which is used to describe material not useful to the organisation (sometimes,
used also for obsolete and surplus items when these are not useful to the organisation). Scrap can be
defined as the residue from a construction or manufacturing process which cannot be used economically
within the organisation. Typical scrap material in the construction industry are empty tins, drums, and
packing material etc.

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3.1 Reasons for Obsolescence

Following are some of the reasons of obsolescence:

(a) Development of better and more efficient or cost economic technology,

(b) Advent of new Automation technologies and design changes,
(c) Standardisation of items within the organisation,
(d) Cannibalisation of equipment to obtain spares for the other,
(e) Incorrect purchase practices like buying in bulk, and
(f) Faulty store keeping or inefficient material handling.

3.2 Control of Obsolescence

Computerised maintenance of records can help largely in identifying potential obsolete items. Market
intelligence should be practiced as a norm. Using the FSN analysis, the non-moving (N) items can be
tracked. Care should be taken that the critical or insurance items are not be included in this list.
This method can also be combined with the XYZ analysis to identify obsolete items.
X -items account for 70% of value but about 10% of stock items,
Y -items account for 20% of value but about 20% of stock items, and
Z - items account for 10% of value but about 70% of stock items.
Here, items coming in Y and Z category need attention whereas X category items are very critical as
they constitute a large value. Other than very necessary or insurance items, the excess items should be
used or disposed quickly.
One way of controlling can be to introduce buyback clause or having centralised purchase which can
better plan to keep a low spares level as it can divert these to other sites.

3.3 Control of Scrap

It may seem odd that scrap requires control. But the following aspects need to be addressed effectively:
(a) Proper storage and dumping places of scrap need to be identified. It is usual in India to see that all
construction sites or warehouses are littered nearby with scrap.
(b) Assess the performance of staff by assessing the cleanliness of the place.
(c) Fix tolerance limits itself on the production of scrap. Explaining the efficient use can control the use
of cloth.
(d) Scrap should be segregated and sold as this fetches better value. They can be separated as drums of
cement, gunny bags, tin of paints etc.
(e) Reclamation should be used wherever possible by seeing the economics.

Responsibility for Disposal

If the procurement department is located nearby or in the same premises, they should be given the
responsibility of disposal. Otherwise, the stores manager is the best person for the job. Since the
procurement or purchase manager has brought the material, it is likely that he keeps track of the
market value of the scrap. The salesmen who interact with him can provide him the feedback for
this purpose. It is needless to add here that the purchase, stores and accounting department have to
function as a team. A typical format of "Form of Request for Write-off &
Disposal" is given in Appendix A.

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Disposal Methods
Depending on the nature of scrap, various methods can bc prescribed. Before disposal action can
be initiated, the "paperwork" for the same has to be initiated as the stock levels as well as its value
change after this. Scrap disposal can be done in the form given below:
(a) By inviting offers from time to time,
(b) By auction, and
(c) By annual contract.
Scrap should be segregated and kept compactly and separately. Some scrap like glass wool is
dangerous and should be collected and covered. To save even the scrap collection costs, the rate
contracts or annual contracts can include even the collection of scrap from the sites. However, care
should be exercised when the collection is going on that no good material leaves the site. In this
way, the scarce manpower and its associated costs can be utilised for other constructive work.
Sometimes, the scrap (like bad earth) is not collected by anyone. In such cases, the disposal is the
responsibility of the organisation and the legal and valid dumping place should be determined
before the material is dumped there.

Distribution Network Design

The Role of Distribution in the Supply Chain:
Distribution refers to the steps taken to move and store a product from the supplier stage to a
customer stage in the supply chain. Distribution occurs between every pair of stages in the
supply chain. Raw materials and components are moved from suppliers to manufacturers,
whereas finished products are moved from the manufacturer to the end consumer. Distribution
is a key driver of the overall profitability of a firm because it affects both the supply chain cost
and the customer value directly.

The process of designing a distribution network has two broad phases. In the first phase,
the broad structure of the supply chain network is visualized. This phase decides the number
of
stages in the supply chain and the role of each stage. The second phase then takes the broad
structure and converts it into specific locations and their capability, capacity, and demand
allocation.

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Figure 3.1 Distribution network in the supply chain

Factors influencing distribution network design:

At the highest level, performance of a distribution network should be evaluated along two
dimensions:

1. Value provided to the customer

2. Cost of meeting customer needs

Although customer value is affected by many factors, we focus on measures that are
influenced by the structure of the distribution network: Based on the value provided to the
customers the following factors influences the distribution network design.

• Response time
• Product variety
• Product availability
• Customer experience
• Time to market
• Order visibility
• Returnability

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Response time is the amount of time it takes for a customer to receive an order.

Product variety is the number of different products or configurations that are offered by the
distribution network.

Product availability is the probability of having a product in stock when a customer order
arrives.

Customer experience includes the ease with which customers can place and receive orders and
the extent to which this experience is customized. It also includes purely experiential aspects,
such as the possibility of getting a cup of coffee and the value that the sales staff provides.

Time to market is the time it takes to bring a new product to the market.

Order visibility is the ability of customers to track their orders from placement to delivery.
Returnability is the ease with which a customer can return unsatisfactory merchandise and the
ability of the network to handle such returns.

Based on the cost of meeting customer needs the following factors influences the distribution
network design.

• Inventories
• Transportation
• Facilities and handling
• Information

Inventories

As the number of facilities in a supply chain increases, the required inventory increases as
shown in Figure 3.2. To decrease inventory costs, firms try to consolidate and limit the number
of facilities in their supply chain network.

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Figure 3.2 . Relationship Between Number of Facilities and Inventory cost

Transportation

Inbound transportation costs are the costs incurred in bringing material into a facility.
Outbound transportation costs are the costs of sending material out of a facility. Outbound
transportation costs per unit tend to be higher than inbound costs because inbound lot sizes are
typically larger. For example, an Amazon warehouse receives full truckload shipments of
books on the inbound side, but ships out small packages with only a few books per customer
on the outbound side. Increasing the number of warehouse locations decreases the average
outbound distance to
the customer and makes outbound transportation distance a smaller fraction of the total distance
traveled by the product. Thus, as long as inbound transportation economies of scale are
maintained, increasing the number of facilities decreases total transportation cost, as shown in
Figure
3.3. If the number of facilities is increased to a point at which inbound lot sizes are also very
small and result in a significant loss of economies of scale in inbound transportation, increasing
the number of facilities increases total transportation cost, as shown in Figure 3.3.

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Figure 3.3 . Relationship Between Number of Facilities and Transportation cost

Facilities and handling

Facility costs decrease as the number of facilities is reduced, as shown in Figure 3.4, because
a consolidation of facilities allows a firm to exploit economies of scale. Total logistics costs
are the sum of inventory, transportation, and facility costs for a supply chain network. As the
number of facilities increases, total logistics costs first decrease and then \ increase, as shown
in Figure 3.5. Each firm should have at least the number of facilities that minimizes total
logistics costs. Amazon has more than one warehouse primarily to reduce its logistics costs
(and improve response time). If a firm wants to reduce the response time to its customers
further, it may have to increase the number of facilities beyond the point that minimizes
logistics costs. A firm should add facilities beyond the cost-minimizing point only if managers
are confident that the increase in revenues because of better responsiveness will be greater than
the increase in costs because of the additional facilities.

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Figure 3.4 . Relationship Between Number of Facilities and Facility cost

Figure 3.5 . Variation in Logistics Cost and Response Time with Number of Facilities

Design options for a distribution network

In this section, we discuss distribution network choices from the manufacturer to the end
consumer. When considering distribution between any other pair of stages, such as supplier to
manufacturer or even a service company serving its customers through a distribution network,
many of the same options still apply. Managers must make two key decisions when designing
a distribution network:

1. Will product be delivered to the customer location or picked up from a prearranged site?
2. Will product flow through an intermediary (or intermediate location)?

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Based on the firm’s industry and the answers to these two questions, one of six distinct
distribution network designs may be used to move products from factory to customer. These
designs are classified as follows.

1. Manufacturer storage with direct shipping

2. Manufacturer storage with direct shipping and in-transit merge
3. Distributor storage with carrier delivery
4. Distributor storage with last-mile delivery
5. Manufacturer/distributor storage with customer pickup
6. Retail storage with customer pickup

Manufacturer storage with direct shipping

In this option, product is shipped directly from the manufacturer to the end customer, bypassing
the retailer (who takes the order and initiates the delivery request). This option is also referred
to as drop-shipping. The retailer carries no inventory. Information flows from the customer,
via the retailer, to the manufacturer, and product is shipped directly from the manufacturer to
customers, as shown in Figure 3.6.

3.6 Manufacturer Storage with Direct Shipping

The biggest advantage of drop-shipping is the ability to centralize inventories at the

manufacturer, which can aggregate demand across all retailers that it supplies. As a result, the
supply
chain is able to provide a high level of product availability with lower levels of inventory. A
key
issue with regard to drop-shipping is the ownership structure of the inventory at the
manufacturer. If specified portions of inventory at the manufacturer are allocated to individual
retailers,

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there is little benefit of aggregation even though the inventory is physically aggregated. Benefit
of aggregation is achieved only if the manufacturer can allocate at least a portion of the
available
inventory across retailers on an as-needed basis. The benefits from centralization are highest
for
high-value, low-demand items with unpredictable demand.

Although inventory costs are typically low with drop-shipping, transportation costs are
high because manufacturers are farther from the end consumer. With drop-shipping, a customer
order including items from several manufacturers will involve multiple shipments to the
customer. This loss in aggregation of outbound transportation also increases cost.

Table 3.1 Performance Characteristics of Manufacturer Storage with Direct Shipping Network

Supply chains save on the fixed cost of facilities when using drop-shipping because all
inventories are centralized at the manufacturer. This eliminates the need for other warehousing
space in the supply chain. There can be some savings of handling costs as well, because the
transfer from manufacturer to retailer no longer occurs. Handling cost savings must be
evaluated
carefully, however, because the manufacturer is now required to transfer items to the factory
warehouse in full cases and then ship out from the warehouse in single units. The inability of
a
manufacturer to develop single-unit delivery capabilities can have a significant negative effect

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on
handling cost and response time. Handling costs can be reduced significantly if the
manufacturer
has the capability to ship orders directly from the production line.

Manufacturer storage with Direct shipping and in-Transit Merge

Unlike pure drop-shipping, under which each product in the order is sent directly from its
manufacturer to the end customer, in-transit merge combines pieces of the order coming from
different locations so the customer gets a single delivery. Information and product flows for
the in-transit merge network are shown in Figure 3.7 . In-transit merge has been used by Dell
and can be used by companies implementing drop-shipping. When a customer ordered a PC
from Dell along with a Sony monitor (during Dell’s direct selling period), the package carrier
picked up the PC from the Dell factory and the monitor from the Sony factory; it then merged
the two at a hub before making a single delivery to the customer.

Figure 3.7 In-Transit Merge Network

As with drop-shipping, the ability to aggregate inventories and postpone product customization
is a significant advantage of in-transit merge. In-transit merge allowed Dell and Sony to hold
all their inventories at the factory. This approach has the greatest benefits for products with
high value whose demand is difficult to forecast, particularly if product customization can be
postponed. ned.

Although an increase in coordination is required, in-transit merge decreases transportation

costs relative to drop-shipping by aggregating the final delivery.

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Table 3.2 Performance Characteristics of In-Transit Merge

Distributor storage with Carrier Delivery

Under this option, inventory is held not by manufacturers at the factories, but by distributors/
retailers in intermediate warehouses, and package carriers are used to transport products from
the intermediate location to the final customer. Information and product flows when using
distributor storage with delivery by a package carrier are shown in Figure 3.8.

3.8 Distributor Storage with Carrier Delivery

Relative to manufacturer storage, distributor storage requires a higher level of inventory

because of a loss of aggregation. From an inventory perspective, distributor storage makes
sense for products with somewhat higher demand.
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Transportation costs are somewhat lower for distributor storage compared with those for
manufacturer storage because an economic mode of transportation (e.g., truckloads) can be
employed for inbound shipments to the warehouse, which is closer to the customer. Unlike
manufacturer storage, under which multiple shipments may need to go out for a single customer
order with multiple items, distributor storage allows outbound orders to the customer to be
bundled into a single shipment, further reducing transportation cost. Distributor storage
provides
savings on the transportation of faster-moving items relative to manufacturer storage.

Table 3.3 Performance Characteristics of Distributor Storage with Carrier Delivery

Response time under distributor storage is better than under manufacturer storage because
distributor warehouses are, on average, closer to customers, and the entire order is aggregated
at
the warehouse before being shipped.

Distributor storage with last-Mile Delivery

Last-mile delivery refers to the distributor/retailer delivering the product to the customer’s
home

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instead of using a package carrier. The automotive spare parts industry

is one in which distributor storage with last-mile delivery is the dominant model. It is too
expensive for dealers to carry all spare parts in inventory. Thus, original equipment
manufacturers
(OEMs) tend to carry most spare parts at a local distribution center typically located no more
than a couple of hours’ drive from their dealers and often managed by a third party.

Figure 3.9 Distributor Storage with Last-Mile Delivery

Unlike package carrier delivery, last-mile delivery requires the distributor warehouse to be
much closer to the customer. Given the limited radius that can be served with last-mile delivery,
more warehouses are required compared to when package delivery is used. The warehouse
storage with last-mile delivery network is as shown in Figure 3.9.

Distributor storage with last-mile delivery requires higher levels of inventory than the other
options (except for retail stores) because it has a lower level of aggregation. From an inventory
perspective, warehouse storage with last-mile delivery is suitable for relatively fast-moving
items
that are needed quickly and for which some level of aggregation is beneficial. Auto parts
required
by car dealers fit this description.

Among all the distribution networks, transportation costs are highest for last-mile delivery,
especially when delivering to individuals. This is because package carriers aggregate delivery
across many retailers and are able to obtain better economies of scale than are available to a
distributor/retailer attempting last-mile delivery.

Table 3.4 Performance Characteristics of Distributor Storage with Last-Mile Delivery

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Response times for last-mile delivery are faster than those for package carriers. Product variety
is generally lower than for distributor storage with carrier delivery.
The cost of providing product availability is higher than for every option other than retail stores.
The customer experience can be good using this option, particularly for bulky, hard-to-carry
items. Time to market is even higher than for distributor storage with package carrier delivery
because the new product has to penetrate deeper before it is available to the customer. Order
visibility is less of an issue, given that deliveries are made within 24 hours.

Manufacturer or Distributor storage with Customer pickup

In this approach, inventory is stored at the manufacturer or distributor warehouse, but

customers
place their orders online or on the phone and then travel to designated pickup points to collect
their merchandise. Orders are shipped from the storage site to the pickup points as needed. The
information and product flows shown in Figure 3.10.

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Figure 3.10 Manufacturer or Distributor storage with Customer pickup

Inventory costs using this approach can be kept low, with either manufacturer or distributor
storage to exploit aggregation. Transportation cost is lower than for any solution using package
carriers because significant aggregation is possible when delivering orders to a pickup site.
This allows the use of truckload or less-than-truckload carriers to transport orders to the pickup
site.

Table: 3.5 Manufacturer or Distributor storage with Customer pickup

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Retail storage with Customer pickup

In this option, often viewed as the most traditional type of supply chain, inventory is stored
locally at retail stores. Customers walk into the retail store or place an order online or by phone
and pick it up at the retail store. Local storage increases inventory costs because of the lack of
aggregation. For fast- to very fast-moving items, however, there is marginal increase in
inventory, even with local storage.
Transportation cost is much lower than with other solutions because inexpensive modes of
transport can be used to replenish product at the retail store. Facility costs are high because
many
local facilities are required. A minimal information infrastructure is needed if customers walk
into the store and place orders. For online orders, however, a significant information
infrastructure is needed to provide visibility of the order until the customer picks it up. Good
response times can be achieved with this system because of local storage. Product variety
stored locally is lower than that under other options. It is more expensive than with all other
options to provide a high level of product availability. Customer experience depends on
whether or not the customer likes to shop. Time to market is the highest with this option because
the new product must penetrate through the entire supply chain before it is available to
customers. Order visibility is extremely important for customer pickups when orders are placed
online or by phone. Returns can be handled at the pickup site. Overall, returnability is fairly
good using this option.
Table: 3.6 Performance Characteristics of Retail Storage at Consumer Pickup Sites

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Models for facility location and Capacity allocation

A manager’s goal when locating facilities and allocating capacity should be to maximize the
overall profitability of the resulting supply chain network while providing customers with the
appropriate responsiveness. Revenues come from the sale of product, whereas costs arise from
facilities, labor, transportation, material, and inventories. The profits of the firm are also
affected by taxes and tariffs. Ideally, profits after tariffs and taxes should be maximized when
designing a supply chain network.

A manager must consider many trade-offs during network design. For example, building
many facilities to serve local markets reduces transportation cost and provides a fast response
time, but it increases the facility and inventory costs incurred by the firm.

Managers use network design models in two situations. First, these models are used to
decide on locations where facilities will be established and determine the capacity to be
assigned to each facility. Managers must make this decision considering a time horizon over
which locations and capacities will not be altered (typically in years). Second, these models are
used to assign current demand to the available facilities and identify lanes along which product
will be transported. Managers must consider this decision at least on an annual basis as demand,
prices, exchange rates, and tariffs change. In both cases, the goal is to maximize the profit while
satisfying customer needs. The following information ideally is available in making the design
decision:

• Location of supply sources and markets

• Location of potential facility sites
• Demand forecast by market
• Facility, labor, and material costs by site
• Transportation costs between each pair of sites
• Inventory costs by site and as a function of quantity
• Sale price of product in different regions
• Taxes and tariffs
• Desired response time and other service factors

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