Term II: Supply Chain Management (SCM)

Session 12: Transportation in the Supply Chain

Rohit Gupta
Operations Management Area
IIM Ranchi
Email: rohit.gupta@iimranchi.ac.in
The Role of transportation in a Supply chain

Transportation refers to the movement of product from one location to another as it makes
its way from the beginning of a supply chain to the customer.

Transportation is an important supply chain driver because products are rarely produced
and consumed in the same location.

Transportation is a significant component of the costs incurred by most supply chains.

Any supply chain’s success is closely linked to the appropriate use of transportation. IKEA,
the home furnishings retailer, has built a global network, with about 350 stores in 42
countries, primarily on the basis of effective transportation.

Supply chains also use responsive transportation to centralize inventories and operate with
fewer facilities. For example, Amazon relies on package carriers and the postal system to
deliver customer orders from centralized warehouses
The Role of transportation in a Supply chain

Transportation related decisions affect the cost as well as responsiveness of the supply
chain. The key transportation decisions made by a firm are:

Selection of transportation strategy: The transportation strategy involves designing the

most effective way of reaching the products to geographically dispersed market from plants
in a cost effective manner.

Choice of transportation mode: Choosing the most effective mode of transport from
among several feasible options.

Firms like Toyota, Kirloskar and Amul Dairy have worked with several innovations like
crossdocking and use of milk run to align their transportation strategy with their overall
supply chain strategy. Facility location, transportation, and inventory management are
interrelated decisions, so a firm has to evaluate the impact of transportation decisions on the
total cost of supply chain.
Factors Affecting Transportation Decisions

Carrier (party that moves or transports the product)

 Vehicle-related cost
 Fixed operating cost
 Trip-related cost

Shipper (party that requires the movement of the product between two points in the
supply chain)

 Transportation cost
 Inventory cost
 Facility cost

Transportation Principles

Economy of Scale
Economy of Distance (Tapering Principle)
 Economies of Scale

The more items (weight) is transported, the less the transportation costs per item (unit of weight).

$100/book

Transportation
Cost per Book

$.10/book

1 1000
Number of Books in Shipment
 Economies of Distance

The larger the distance, the less the transportation costs per unit of distance (e.g., per mile).

$.10/mile

Transportation $.05/mile
Cost per Mile

Tapering Principle

$50/mile

1 mile 500 miles 1000 miles

Shipment Distance
Transportation Participants

I need something
shipped at the lowest
I need something
possible cost!
delivered at the lowest
possible cost!
Transportation Participants

Carriers: We have the

Carriers – we can find a shipper! equipment!
Shippers – we can find a carrier!
 Transportation Participants

Creates demand for

transportation by purchasing
products

the transportation system

is vital for the country’s
economic health track shipments

purchase fuel, match products needing to

transportation be shipped with available
equipment, supplies capacity
Five Basic Transportation Modes

Pipeline Water

Air

Rail

Highway
Package Carriers
 Cost Structure For Each Transportation Mode

Rail

 High fixed costs (land, tracks)

 Low variable costs (operating costs, e.g., labor, fuel)
 Slow, but inexpensive way to transport heavy freight that doesn’t require special
handling, long distances

Major Issues
 Scheduling to minimize delays / improve service
 Off-track delays (at pickup and delivery end)
 Yard operations
 Variability of delivery times
 Highway

 Low fixed costs (government builds, maintains highways)

 Medium-high variable costs (operating costs, e.g., labor, fuel)
 Most accessible mode (more highways than railroads, waterways, pipelines); best for
transporting medium to high value products short to moderate distances

 LTL – less than truckload Major Issues

 TL – truckload  Utilization
 Specialty  Consistent service
 Backhauls
 Vehicle routing
Water

 Moderate fixed costs (ships and freight handling equipment)

 Low variable costs (operating costs, e.g., labor, fuel)
 Very slow, but inexpensive way to transport large, heavy freight over long distances
(e.g., oceans, rivers, inland waterways, lakes)
 Dominant in global trade (autos, grain, apparel, etc.)
 Limited to certain geographic areas
Air

 Relatively low fixed costs (aircraft and freight handling equipment)

 Highest variable costs (e.g., labor, fuel, maintenance)
 Very fast; used for transporting high value and/or high perishability product over
short to medium distances.

Key issues

 Location/number of hubs
 Location of fleet bases/crew bases
 Schedule optimization
 Fleet assignment
 Crew scheduling
 Pipeline

 Highest fixed costs (right of way & construction costs of equipment)

 Lowest variable costs (no significant labor or fuel costs)
 Fast, dependable (e.g., no weather, traffic disruptions); no flexibility with regard to
types of products that can be transported – must be fluid (e.g., petroleum, gas)
 Best for large and predictable demand
Package Carriers

 Companies like FedEx, UPS, USPS, that carry small packages ranging from letters to
shipments of about 150 pounds

 Expensive

 Rapid and reliable delivery

 Small and time-sensitive shipments

 Preferred mode for e-businesses (e.g., Amazon, Dell, McMaster-Carr)

 Consolidation of shipments (especially important for package carriers that use air as a
primary method of transport)
 Intermodal

 Use of more than one mode of transportation to move a shipment to its destination

 Most common example: rail/truck

 Also water/rail/truck or water/truck

 Grown considerably with increased use of containers

 Increased global trade has also increased use of intermodal transportation

 More convenient for shippers (one entity provides the complete service)

 Key issue involves the exchange of information to facilitate transfer between different
transport modes
Design Options for a Transportation Network

The design of a transportation network affects the performance of a supply chain by

establishing the infrastructure within which operational transportation decisions regarding
scheduling and routing are made.

 Direct shipping network

 Direct shipping with milk runs

 All shipments via central DC

 Shipping via DC using milk runs

 Tailored network
Direct Shipment network to single destination

With the direct shipment network to a single destination

option, the buyer structures the transportation network so
that all shipments come directly from each supplier to
each buyer location.

The routing of each shipment is specified, and the supply

chain manager needs to decide only the quantity to ship
and the mode of transportation to use.

The major advantage of a direct shipment transportation

network is the elimination of intermediate warehouses
and its simplicity of operation and coordination.

The shipment decision is completely local, and the decision made for one shipment does not influence
others. The transportation time from supplier to buyer location is short because each shipment goes direct.

A direct shipment network to single destination is justified only if demand at buyer locations is large
enough that optimal replenishment lot sizes are close to a truckload from each supplier to each location.
Direct Shipment with Milk Runs

A milk run is a route on which a truck

either delivers product from a single
supplier to multiple retailers or goes
from multiple suppliers to a single buyer
location.

Direct shipping provides the benefit of

eliminating intermediate warehouses,
whereas milk runs lower transportation
cost by consolidating shipments to
multiple locations on a single truck.

Milk runs make sense when the quantity destined for each location is too small to fill a truck but
multiple locations are close enough to each other such that their combined quantity fills the truck.

For example, Toyota uses milk runs from suppliers to support its just-in-time (JIT) manufacturing
system in both Japan and the United States.
All shipments via intermediate distribution center with storage

Under this option, product is shipped from

suppliers to a central distribution center,
where it is stored until needed by buyers
when it is shipped to each buyer location.

Storing product at an intermediate location

is justified if transportation economies
require large shipments on the inbound side
or shipments on the outbound side cannot
be coordinated.

The presence of a DC allows a supply chain to achieve economies of scale

All Shipments via intermediate transit points with Cross-Docking

Under this option, suppliers send their shipments to an intermediate transit point (which could
be a DC), where they are cross-docked and sent to buyer locations without storing them.

The product flow is similar to that previous one except that there is no storage at the
intermediate facility.

When a DC cross-docks product, each inbound truck contains product from suppliers for
several buyer locations, whereas each outbound truck contains product for one buyer location
from several suppliers.

Major benefits of cross-docking are that little inventory needs to be held and product flows
faster in the supply chain. Cross-docking also saves on handling cost because product does
not have to be moved into and out of storage.
Shipping via DC with Milk Runs

Milk runs can be used from a DC if

lot sizes to be delivered to each
buyer location are small.

Milk runs reduce outbound

transportation costs by consolidating
small shipments.

The use of cross-docking with milk

runs requires a significant degree of
coordination and suitable routing
and scheduling.
Tailored Network

The tailored network option is a suitable combination of previous options that reduces the
cost and improves the responsiveness of the supply chain.

Here, transportation uses a combination of cross-docking, milk runs, and TL (Truck Load)
and LTL (Low Truck Load) carriers, along with package carriers (Such as FedEx, Indian
Post) in some cases.

The goal is to use the appropriate option in each situation.

High-demand products may be shipped directly to high-demand retail outlets, whereas low-
demand products or shipments to low demand retail outlets are consolidated to and from the
DC.

The complexity of managing this transportation network is high because different shipping
procedures are used for each product and retail outlet.
Cross Docking

Amazon’s China subsidiary has received United States approval to ship ocean freight for other
companies. That could make it cheaper and easier for sellers on Amazon to move goods from
Chinese factories to Amazon’s American warehouses.
With this move Amazon China could start “cross-docking” goods in United States ports “for
direct injection into Amazon’s courier network.”
–NY Times Report (January 14, 2016)

Wal-Mart receives goods from its vendors at loading docks and its massive fleet of trucks take
these to the warehouses, which are usually located in the range of 130 miles from the stores.
For distribution purposes, Wal-Mart uses the technique of cross-docking to reduce or (in some
cases) eliminate the intermediate storage costs.
– (Too many articles have reported this news!)
Cross Docking – Points to remember
Cross-docking refers to the direct transfer of goods from vendor end (incoming shipments) to warehouses
(via outgoing vehicles) without any storage in between.
This practice can serve different goals:
 Consolidation of shipments (Capacity utilization of vehicles)
 Shorter delivery lead time
 Reduction of total costs (Delivery + ICC)
 Usage of entire capacity of the truck ensures less emission
Note: Cross-docking is probably not the best strategy in every case and in all circumstances.
Two major factors influence the decision of cross docking and they are as follows:
(1) Product Demand Rate: If there is an imbalance between the incoming load and the outgoing load,
cross-docking will not work well.
Hence, goods that are more suitable for cross-docking are the ones that have demand rates that are
more or less stable (e.g. grocery and regularly consumed perishable food items).
For these products, the warehousing and transportation requirements are much more predictable, and
consequently the planning and implementation of cross-docking becomes easier.
Cross Docking – Points to remember (cont...)

(2) Unit Stock-out Cost: As cross-docking minimizes the level of inventory at the warehouse,
the probability of stock-out situations is higher.
If the unit stock-out cost is low, the benefits of cross-docking can outweigh the increased
stock-out cost, and so cross-docking can still be the preferred strategy.

Product Demand Rate

Stable & Constant Unstable/ Fluctuating
Cross-docking can be
Unit Stock-out

Traditional Distribution
High implemented with proper
preferred
Costs

systems & planning tools

Cross-docking can be
Low Cross-docking preferred implemented with proper
systems & planning tools
Choice of Transportation mode based on cost trade off (Q 14.2)
Eastern Electric purchases motors from Westview Motors. The relevant details are
given below: Number of motors purchased per year = 1,20,000
Purchase Price = $ 120
Weight per motor = 10 lb = 0.1 cwt
Safety inventory (%age of lead time demand) = 50%
Annual Inventory Holding cost (%age of Price) = 25%
Eastern Electric has received following proposals from 3 different logistics companies.
Carrier Qty Shipped (cwt) Shipping cost ($/cwt) Transit time (days)
AM Railroad 200+ $ 6.50 5
Northeast trucking 100+ $ 7.50 3
50 – 150 $ 8.00 3
Golden Freightways
150.1 – 250 $ 6.00 3
(marginal qty discount)
250 + $ 4.00 3
As per the process followed by Westview, the lead time (LT) for shipment becomes:
LT = (Transit Time + 1) day
Compare between the following transportation options: Options Lot Size (motors)
AM Rail 2,000
Northeast 1,000
Golden Freightways 500
Golden Freightways 1,500
Golden Freightways 2,500
Golden Freightways 3,000
Choice of Transportation mode based on cost trade off (Solution)
Quantity Shipped Quantity shipped Shipping cost
Carrier (cwt) (motors) ($/cwt)
AM Railroad 200+ 200+/ 0.1 = 2000+ $ 6.50
Northeast trucking 100+ 1000+ $ 7.50
Golden Freightways 50 – 150 500-1500 $ 8.00
Golden Freightways 150.1 – 250 1501-2500 $ 6.00
Golden Freightways 250+ 2500+ $ 4.00

Therefore, for the given transportation options we can calculate the effective
shipping cost as follows:
Options Lot Size (Motors) Effective Shipping Cost [ESC] ($/cwt)
AM Rail 2,000 $ 6.50
Northeast 1,000 $ 7.50
Golden Freightways 500 $ 8.00
Golden Freightways 1,500 $ 8.00
Golden Freightways 2,500 (1500x8 + 1000x6)/2500 = $ 7.20
Golden Freightways 3,000 (1500x8 + 1000x6 + 500x4)/ 3000 = $ 6.67

Transportation Cost would be calculated as follows:

Annual Demand (in cwt) x Effective Shipping Cost ($/ cwt)
For calculation of inventory we need to remember these previously discussed formula:
(A) Cycle Inventory (B) In-transit inventory (C) Safety Inventory
Choice of Transportation mode based on cost trade off (Solution)
Cycle Inventory: average inventory that a firm holds in accordance with the decided lot
size.
Therefore, Cycle Inventory = Lot Size/ 2
Transit time means the time required for passing of goods from one location to another.
Even while goods are moving, an inventory cost is incurred (The longer the transit time, the
higher the inventory cost).
In-transit Inventory is calculated as: demand generated over the transit time.
Safety Inventory: 50% of the lead time inventory [as per the question]

Calculation for Option 1: AM Railroad

Lot size = 2000; Transit Time = 5 days, Lead Time = 5+1 = 6 days
Cycle Inventory = 2000/ 2 = 1000
In-transit Inventory = 120,000 x (5/365) = 1644
Safety Inventory = 50% x {120,000 x (6/365)} = 986
Total Inventory = 1000 + 1644 + 986 = 3630
Inventory Holding Cost = 25% x (3630 x 120) = 108,900
Transportation Cost = 120,000 x 0.1 x 6.5 = 78,000
Total Cost of using Option 1 = 108,900 + 78,000 = 186,900
 Choice of Transportation mode based on cost trade off (Solution)
In-
Annual Cycle Lead Safety Transit Total
Lot Size ESC Transport Invento Time Inventor Inventor Inventor Holding
Options (Motors) ($/ cwt) ation Cost ry (days) y y y Cost Total Cost

AM Rail 2,000 $ 6.50 $ 78,000 1,000 6 986.30 1,643.84 3,630.14 $ 1,08,904 $ 1,86,904

Northeast 1,000 $ 7.50 $ 90,000 500 4 657.53 986.30 2,143.84 $ 64,315 $ 1,54,315

Golden 500 $ 8.00 $ 96,000 250 4 657.53 986.30 1,893.84 $ 56,815 $ 1,52,815

Golden 1,500 $ 8.00 $ 96,000 750 4 657.53 986.30 2,393.84 $ 71,815 $ 1,67,815

Golden 2,500 $ 7.20 $ 86,400 1,250 4 657.53 986.30 2,893.84 $ 86,815 $ 1,73,215

Golden 3,000 $ 6.67 $ 80,000 1,500 4 657.53 986.30 3,143.84 $ 94,315 $ 1,74,315

Question 14- 2 Extension:

Assume that you are the manager of Northeast and somehow all bid information are
available with you. If you have the option of changing the value of shipping cost, how
should you change it’s value so that Northeast emerges as the cost leader?
Understanding the theory of transportation cost trade-off
Annual demand of the product = D (for Q 14-2 it’s value is 120,000)
Weight of each product = w (for Q 14-2 it’s value is 0.1 cwt)
Total weight that is required to be transported = Dw (12,000 cwt)
Per unit (effective) transportation cost = c (in $/ cwt, and this value changes from firm to
firm)
Total cost of transportation = Dwc

Per unit price of the product = p (for Q 14-2 it’s value is $120)
Per unit annual hold cost = h = αp (where 0 ≤ α ≤ 1; for Q 14-2, α = 0.25)
Transit time = t (in days, and and this value changes according to the mode of transportation,
e.g. in Q 14-2 Railroad transit is 5 days, Truck transit is 3 days)
Lead time = l = t + β (in days, it is process dependent and in Q 14-2, β = 1)
Lot size = Q (this value changes from firm to firm, e.g. in Q 14-2, for AM Rail, Q = 2000
and for Northeast, Q = 1000 etc.)

Cycle Inventory = Q/2

In-transit Inventory = (D/d)×t , where d = number of working days in 1 year (in Q 14-2, this
value is taken as 365)
Safety inventory = (D/d)×{(t + β)/2}, i.e. 50% of lead time inventory as per Q 14-2.
Understanding the theory of transportation cost trade-off (contd.)
𝑄 𝐷 𝑡+β
Total inventory is I = 2
+𝑑 𝑡+ 2
𝑄 𝐷 𝑡+β 𝑄 𝐷 𝑡+β
Inventory holding cost is: 𝐶 𝐼 = h 2
+𝑑 𝑡+ 2
= αp 2
+𝑑 𝑡+ 2
𝑄 𝐷 𝑡+β
Total cost is: T 𝑞 = 𝐷𝑤𝑐 + 𝐶 𝐼 = 𝐷𝑤𝑐 + αp 2
+𝑑 𝑡+ 2
Observe: For the same mode of transportation, the value of t is constant.
𝑄
In that case, the relevant cost component is: 𝐷𝑤𝑐 + αp 2
In Q 14-2 (E), Golden and Northeast are road transport companies with identical t value.
Therefore Northeast can emerge as cost leader if and only if:
𝑄𝑁 𝑄𝐺
𝐷𝑤𝑐𝑁 + αp < 𝐷𝑤𝑐𝐺 + αp
2 2
1000 500
or, 120,000 × 0.1 × 𝑐𝑁 + 0.25×120 < 120,000 × 0.1 × 8 + 0.25×120
2 2
or, 𝑐𝑁 < 7.375
Therefore, at 𝑐𝑁 = 7.375 the total cost of Northeast is equal to that of Golden.
At 𝑐𝑁 = 7.3 (< 7.375), say, Northeast becomes the cost leader.
Understanding the theory of transportation cost trade-off (contd.)
In-
Lot Size Transport Cycle Lead Transit Total
(Motors ation Transportati Invento Time Safety Inventor Inventor Holding
Options ) Cost/cwt on Cost ry (days) Inventory y y Cost Total Cost
4
Northeast 1,000 $ 7.50 $ 90,000 500 657.53 986.30 2,143.84 $ 64,315 $ 1,54,315
4
Northeast 1,000 $ 7.375 $ 88,500 500 657.53 986.30 2,143.84 $ 64,315 $ 1,52,815
4
Northeast 1,000 $ 7.30 $ 87,600 500 657.53 986.30 2,143.84 $ 64,315 $ 1,51,915
4
Golden 500 $ 8.00 $ 96,000 250 657.53 986.30 1,893.84 $ 56,815 $ 1,52,815