IESE

International Graduate School of Management

University of Navarra
Barcelona-Madrid

0-693-012
PN-313-E
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LOGISTICS

Introduction
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This technical note will deal with the logistics function within the company. Using
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the model of the Business Activity Sequence and the variables involved, we will discuss the
various ways of organizing the logistics function and its relationships with the other BAS
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activities. Under the term logistics we will group the functions of input logistics and output
logistics which form part of the value added chain of the BAS.
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The term logistics suggests the movement of things from one place to another with a
storage period at some point along the route. A company’s logistics system comprises the
capacities, equipment, people and policies that facilitate the flow of goods, from the purchase
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of the raw materials to the distribution of the final product, so as to place them in the hands of
the customer. The task of the logistics manager is to design a system and operating policies
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that make the flow of goods effective and efficient, as well as to provide a suitable level of
control and coordination.

Input logistics includes the design and operation of the system that ensures that the
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necessary resources are available in the right place, at the right time, with the right quality
and in the right quantity for carrying out the operations. Output logistics is concerned with
the same operations, but with reference to the need to put the product in the place chosen by
the customer for using it.

Logistics has strategic importance in companies. Many companies have found it a

means of achieving a sustainable competitive advantage. Studies show that many American
companies recognize that what differentiates them from their competitors are their logistics
operations. Black & Decker Corp., for example, adapts its logistics operations to meet the
needs of its customers, and is able to integrate the demand from 58 countries and distribute
orders among its 70 production plants.

Technical note of the Research Department at IESE.

Prepared by María José Marhuenda, MBA student, under the supervision of Professor Beatriz Muñoz-Seca.
November 1992.
Copyright © 1992, IESE.
No part of this publication may be reproduced without the written permission of IESE.

Last edition: 5/95

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Several factors have contributed to making logistics an increasingly important and

complex function. These include: technological developments, market globalization, the
creation of alliances, the restructuring of large corporations, the importance of satisfying
the customer, the proliferation of products, and environmental pressures. In the United States
logistics alliances, whereby a manufacturer and a logistics services company design and
implement a customized plan, coordinating their operations and obtaining mutual benefits,
are an increasingly common phenomenon. One example of this is Drug Transportation Inc.,
an Atlanta-based company, for which this type of alliance ensures stable operations and
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guarantees profit. On the other hand, market globalization has led many companies to purchase
logistics companies in the various countries they operate in. Federal Express purchased a
Japanese air freight company and, through this purchase, unrestricted landing rights in
three Japanese airports.

Through logistics, companies can meet challenges and create value for both
customers and shareholders, thereby increasing market share and profits. An example of this
are sales procedures where logistics is linked to the action of selling. This is the case with

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presale or direct selling, common in drink distribution to bars or in the sale of domestic
heating oil. In these cases, the design of the distribution network as regards the number of
vehicles and routes, bearing the mean demand of the customers in mind, will have a

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considerable influence on the company’s sales.
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Our purpose will be to analyze, through our six variables (1), the key issues in
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logistics: structure of the distribution system, optimal location of warehouses, how much in
each warehouse, coordination of materials flow throughout the system, and the most suitable
transportation methods in each case.
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Organization of the function: Variables

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Capacity

The decision about how to organize logistics capacity will always be between
inhouse or subcontracted capacity. A third alternative is the mixed capacity system chosen by
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some companies. In a mixed system, supply from the main factory to the regional factories is
subcontracted, either to a private company or using public transport, while a fleet of
company-owned trucks is used to transport goods from the warehouses to the local
distributors. The main factors to be considered in the decision about whether to have inhouse
or subcontracted capacity include:

The company’s strategic mission. Capacity will vary, depending on whether the
company competes on price or on service to the customer. If cost is a priority criterion,
transportation will be subcontracted to companies that offer good discounts for volume. If
service to the customer is the most important thing, it is more likely that the company will
have a fleet of its own, which, even if it is not operated at 100% capacity, offers greater
flexibility.

Technology available. If the handling of certain goods or materials requires special

techniques or skills which the company does not possess, then the job will be subcontracted.

(1) These six variables are: capacity, flow, process, human resources, conflict-solving and information system.
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This applies in the case of dangerous chemicals, very large objects which have to be
assembled and disassembled, etc. In any case, the technology used in material storage and
handling will contribute to increasing the ability to fulfil the company mission.
This technology can be applied at any stage from the receipt, processing and computerized
monitoring of orders –for example, a MRP– to automatic material storage and recovery
methods. However, when greater flexibility is required and there is a desire to avoid heavy
expenditure on capital equipment, manual methods are used for these functions.
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Geographical factors. It must be remembered that logistics is one of the most

important criteria when deciding a company’s location. Depending on where the company is
located, it may or may not have access to certain means of transport such as trains,
aeroplanes, etc. On the other hand, some companies in isolated areas where there is not a
developed road network use alternative methods such as river or air transport and even
undertake joint programs with regional governments to build the necessary network. This is
what has happened on the frontier between Germany and Poland, where the German
government has built a freeway into Poland to facilitate the flow of goods.

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Regulation. National and international regulation on routes, speeds and other
competitive practices also affect capacity. Thus, the deregulation of air transport that took

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place in the USA had a considerable effect on corporate logistics practices. Deregulating
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transport may lead to a fall in prices that makes it wiser to subcontract than to have inhouse
capacity. Another example of the effect of regulation on the decision to subcontract or to
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develop inhouse capacity is customs legislation and procedures. It may be, for example, that
customs procedures in the countries lying along a given route make it much more expensive
in terms of both time and money to have a company-owned fleet of trucks than to subcontract
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air freight.
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Flow
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As has already been said, logistics is basically a question of flows: of materials and
of information. As regards the flow of materials, two types of decision have to be taken about
how the materials are going to circulate:
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a) Decisions related to the system of warehouses.

b) Decisions related to the means of transport.

a) Systems of warehouses

When designing the system of warehouses, a company must choose between various
alternatives, depending on its way of competing: centralized or decentralized warehouses,
specialized in one product or multiproduct, on the supplier’s premises or on the company’s
own premises. There follows a more detailed discussion of the various alternatives:

1.-Centralized system. Reduces storage costs and increases transport costs. When
cost is the basic criterion, the company will have a rationalized system, sized to give the
lowest possible costs. In such cases, the tendency will be towards a centralized, automated,
consolidated system, with a minimum number of local warehouses. There are several types of
stock-related cost: order costs, storage costs and shipping costs. Poor quality management on
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the part of the warehouse managers may lead to high costs due to obsolete items being kept
in stock or excessively high buffer stocks.

2.-Decentralized system or high local presence. In this case, transport costs are low
but stock costs increase. The decisions that have to be taken in such cases are: the number of
warehouses available in an area, the size of the warehouses and the number of links in the
distribution chain. When service to the customer is the most important criterion, a system of
decentralized warehouses is usually chosen. Although this system is more expensive, as
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storage, transport and material handling costs increase with decentralization, and although it
implies expanded inventories and loss of control over inventories, there is closer contact
with the distribution center. This will lead to a decrease in the number of errors, shorter lead-
times and lower buffer stocks because there are fewer days of uncertainty.

3.-Specialized warehouses (single product) or very different products (multiproduct).

If the company wishes to compete on width of product range, it will have a
multiproduct system of warehouses, which will considerably increase the level of stock

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required in order to be able to guarantee a certain service to the customer.

4.-Warehouse on the customer’s premises or on the supplier’s premises. The latter

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alternative is usually chosen when the company competes on partnership. In such cases, the
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customer-supplier relationship is so close –for example, that of the typical, single just-in-time
supplier– that the goods are deposited on the customer’s premises, so that the customer can
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take them as they are needed, thus providing a better service.

There are mathematical optimization methods and simulation systems that are able
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to integrate a large number of factors so as to find minimal cost or zero cost configurations.
However, when taking the decision, these mathematical considerations are usually
subordinated to qualitative criteria.
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b) Means of transport

A wide range of transport possibilities are available. It is possible to choose between

transport overland –truck, train, pipeline (for oil and gas)–, by air –aeroplane or helicopter–,
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sea or river.

In order to take a decision on the means of transport, the company will need full
information on cost, delivery dates, weight, volume, and other requirements such as cooling,
pressure, documentation required, agreements between different countries, etc.

The choice can be made by considering such varied factors as:

Way of competing

On cost. Transport costs are one of the components that are most easy to control in
the value added chain. Companies interested in reducing these costs to the lowest possible
level should centralize the transport function at corporate level and establish procedures that
make it possible to evaluate how this function is performed. It is also possible to use models
that give the economic order size, taking into account the order size and the means of
transport.
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On service. This aspect is steadily growing in importance. For the customer, good
service means punctual collection and delivery, accurate invoicing, updated and correct
information, and security. Studies show that quality of service is the priority criterion when
choosing a carrier within the international air freight segment. Some companies have
formally defined service quality standards. AT&T, for example, chooses the means of
transport and the carrier company on the basis of: frequency of lost or spoiled goods, speed,
accuracy of invoices, and transit intervals.
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Destination

International. For exports, the factors to be considered when choosing the means of
transport are: time and distance, documentation required, security of load, regulation in the
country of destination, and the means of transport available in that country.

National. When transportation is purely national, these factors will no longer apply

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and one will have to consider the degree of use, the availability of volume discounts, the
possibility of using means of transport as storage locations, the ability to combine various
means of transport, depending on the distances involved, to create mixed systems and

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emergency systems.
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Public transport such as trains, ships, etc. will be used when low costs are required,
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whereas having a company-owned fleet will make it possible to offer a better service to the
customer and allow greater control. This option will be associated with higher costs.
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Transport strategies may also help boost demand, expand market share and
differentiate the product/service offered. This can be achieved by providing customers with
information on transportation, special offers for transport, and relationships with the channel
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to create a competitive advantage that is sustainable in the long term. There is a growing
trend to integrate transportation and customer service.
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Process
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In logistics, process is a synonym of procedure and is understood to be the body of

rules that govern the way each link in the chain relates to those that follow it. Logistics
procedures can be rigid or flexible, that is, they can be formally defined and invariable, or
they can vary to adapt to each situation.

The most common procedures are:

– Order processing.
– Shipment scheduling.
– Selection of means of transport.
– Order expediting.
– Import and export procedures.

The main features of these procedures are defined in the following paragraphs:

Order processing: The methods range from receiving orders by mail and processing
them manually, in the case of small companies with a small number of customers,
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to complex, integrated information systems linking supplier and customer in companies with
a high number of orders and customers. K mart has installed a network of minicomputers that
keeps the shops continually connected with the warehouses, greatly speeding up the receipt
of orders and the dispatch of goods to the shops. Also, depending on the system, there may be
a degree of flexibility that allows the customer to change the specifications or other
conditions of an order.

Shipment scheduling. Shipments may be on fixed days or totally flexible at the

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customer’s request. There may or may not be a minimum order quantity. For example, a
company that competes on cost will wait to fill a truck with the orders for an area before
sending it, while another company that competes on service to the customer will schedule the
shipment with the customer. If the customer needs the order urgently, the company will send
it immediately; otherwise, it will combine it with other orders. At the University of Michigan
Medical Center, for example, UPS and Federal Express set up a point-to-point dispatch
scheduling system. First, they analyzed the various departments’ destinations and identified
and formalized common destination points. A code number was then assigned to the various

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departments. This brought a 30% reduction in the number of delivery addresses, along with
lower costs and improved service levels.

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Selection of means of transport. The complexity of these procedures may vary
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considerably. Some include the definition of different means by load ratios, mean times and
variances. Once this has been done, the reorder points and order quantities that give the lowest
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expected annual costs are calculated. Finally, the annual costs of the various alternatives are
compared and the one that gives the lowest cost is chosen. For Dow Chemical, for example,
safety is the most important factor and if a transport company wishes to be chosen, it must
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demonstrate its ability to satisfy certain safety standards over a period of two years.

Order monitoring. In some cases, the customer has access to the supplier’s
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information system and can verify for itself the status of its order. There may also be very
opaque information systems where it is not possible to extract any information about the
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order’s status because of the lack of communication between the company making the
shipment and the company that has contracted the service.

Goods delivery confirmation procedures. These may range from sending a letter or
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making a telephone call, to the customer removing the order from the integrated database.

Import procedures, customs procedures, etc. These may be more or less complex
depending on the country’s regulations, its agreements, and rules governing overseas trade. In
May 1991 the United States and Japan agreed to establish a system known as the “Sea Cargo
Automated Processing System” in two Japanese ports, Tokyo and Yokohama. The purpose of
the system was to reduce the mean time for import procedures for American goods entering
Japan and thus help redress the US balance of trade deficit with Japan.

The elimination of customs in the EC in 1993 has led to the disappearance of these
import-export and customs clearance procedures. This has greatly eased the flow of goods
within the Community. It is also expected to have consequences similar to those of the
deregulation of transport in the US during the 1980s, which brought a consolidation of the
entire transport system and a consequent reduction in stock levels. In the US deregulation led
many companies to implement just-in-time in their operations and so greatly reduce
inventories. One aspect in which Europe differs from the United States is rail transport since,
although it is not the most important means of transport, certain standards will have to be
established in order to build a single system.
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Human resources

The profile of the people carrying out logistics functions in a company will depend
on whether these activities are done inhouse or subcontracted. If they are done inhouse, the
company will employ specialists in the various areas, depending on its size: warehouse,
transportation, materials handling, etc. In smaller companies these activities will be
centralized under a single person with knowledge of all of them. If these activities are
contracted to other companies, the logistics personnel will be people specialized in
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procedures.

The logistics manager often acts as allocator and coordinator of the various
functions in the company, since logistics controls the flows between the various parts of the
organization. He tends to be skilled at integrating and must be able to combine interrelated
activities. He contributes to decision-making with his skill and knowledge, and is able to
solve conflicts, take on full responsibility and draw on multifunctional experience. Surveys
have been done to discover the ideal qualities of a logistics manager. The results suggest a

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mixture of operational and interpersonal skills, analytic ability, a knowledge of finance and
data processing, and previous experience.

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Conflict-solving
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For any logistics system to work, there has to be a system of priorities for serving
orders and guidelines that enable decisions to be taken at any stage. There must also be
procedures for dealing with emergencies.
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Supplier and customer policies have a strong influence on the design of the logistics
conflict-solving system. They affect decisions regarding the frequency, method and
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notification of shipments. There are two alternatives when designing the logistics system:
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– A ‘pull’ system, anticipating needs, making plans and sending goods to

intermediate nodes in accordance with demand forecasts. The forecast should be
the result of a coordinated effort to harmonize criteria and provide estimates of
future demands and their timing. This is the system used by companies that
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follow the just-in-time approach so as to respond to fluctuations in demand and

smooth out the production curve in the factories. Japanese car retailers, for
example, are asked to try and absorb the quotas set by the producers.

– A ‘push’ system that involves reacting to the needs of the previous level. Each
level maintains inventory levels that are controlled by different policies (product
reorder point, standing order system, MRP-based, more information-intensive
systems) adjusted to the demand of the lower levels. The system’s parameters
should not vary when there are slight variations in demand.

Information systems

The design of the information system determines the time that an order is in the
system until it is attended to. It also helps to manage stocks by following them through
the various links in the chain. The availability of accurate and up-to-date information will
enhance management effectiveness in areas such as the amount invested in stock, forecasts,
number of orders, expediting, evaluation of salesmen and administration of faulty stocks.
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A good information system will help monitor and follow up the way the various
functions are carried out, generate orders for other functions to start an activity, coordinate
activities, and link inhouse activities with outside activities. It is basically used for
administrative tasks such as order receipt and acknowledgment, product review, invoicing, etc.

As the information system grows, it becomes increasingly difficult to maintain

accurate information in the system. This difficulty led the US Army to develop an expert
system to ensure the validation of the data in its information bank.
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Among the alternatives available for the design of the information system are:

– A continuous monitoring system, based in practice on a real-time computer

application. The system is updated with every transaction so that updated
information is constantly available.

– Periodic follow-up system. Here, inventory status is updated periodically. Also,

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orders are made and decisions taken at regular intervals.

Local systems, where each node is fully independent from the others and

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therefore takes decisions independently.
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– Global systems, where an overview of the entire system is collected. This sort of
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system might be found in a distribution network where a central unit processes
information on movements in all the network’s nodes, though not with the same
degree of detail as in the peripheral terminals. For example, it may record only
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the sales volume in dollars at each node, but not the names of the customers that
made the orders.
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Regardless of the information system chosen, computer science has a vital role to
play as it provides the company with a large volume of information in a quick and reliable
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form.

If the production system is based on the just-in-time philosophy, the information

system must fulfil certain special requirements as regards timing, accuracy, information sent
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and received, dealines for action, etc. All these requirements are met thanks to the close
relationship between customers and suppliers, who normally share all the information. It also
requires careful coordination in the exchange of customer and supplier data. For example,
logistics information systems have enabled automobile manufacturers drastically to reduce
stocks and thus increase their competitiveness worldwide.

Position of the logistics function within the BAS

Logistics and R&D&D

Right at the start of the design phase, any features of the product that directly affect
logistics have to be taken into account. This becomes especially important in the case of
perishable goods such as foods and flowers. We might have to consider such things as storage
conditions (refrigeration, humidity, static electricity, etc); the perishability and durability of
products and the use of preservatives in foods and plants; fragility and treatment during
transport, etc.
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In companies that compete on innovation, those that specialize particularly in the

introduction and development of new products, the logistics system must be very flexible as
regards lead-times and small order quantities used for testing or as samples, etc., as in the
early stages of a product’s life this flexibility will be indispensable for gaining market share.

Logistics and quality assurance

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In logistics, quality is defined as obtaining the goods required on time and in perfect
condition. However, these two basic requirements can be broken down into seven aspects:
product, quantity, condition, place, time, customer and cost. For these seven conditions to be
fulfilled, it is vital to have a suitable information system, accurate order data and even a
mechanism or procedure for reacting swiftly to possible problems.

In order to ensure that the products are transported in good condition, the wrapping
or packaging used must be suitable and protect them from accidents or damage in transit.

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This is particularly important in the case of fresh foods as it affects both their taste and their
appearance. Recently, packaging is coming under considerable scrutiny on account of its
environmental impact. As from 1993 countries such as Germany will implement legislation

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aimed at reducing, reusing and recycling packaging materials. The goal is to recover 50% of
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packaging material and recycle between 30 and 70% of the amount recovered. These laws
will affect not only German companies, but also any company that sells its products in
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Germany.

Other items such as the date the product left the factory and the recommended shelf-
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life guarantee the product’s quality when it reaches the consumer, as in the case of most foods
and medicines.
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A growing number of companies are implementing quality programs in logistics.

Most of these companies are customer service-driven, but the lack of logistics strategies
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causes many of them to fail. The most serious problem is the lack of clarity regarding what to
measure, and the lack of information systems to support these measurements. For quality to
be controlled, it must first be defined and measured.
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Logistics and process design

The decisions taken during process design that most directly affect logistics are the
decisions about the size of the production batch, whether it is the same as the size of
the batch packaged and subsequently stored, the batch size that is transported, the degree of
automation and the use of robots in the storage methods and whether these methods are
compatible with the automation of the final stages of the production system.

In order to reduce stock costs and risk, some companies are adopting new
production methods consisting of carrying out only the first stages of the process, those that
are common to the entire product range. These half-processed products are then kept in stock
until the customer sends the order and specifies how he wants them. It is at this point that the
final stages of the process, the finishing, are performed. This new method is known as
“postponement” and is used for some types of integrated circuit, certain items of clothing and
other goods.
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Logistics and purchasing

These functions are so closely related that in some companies they are grouped in
the same department, under the management of the same person. In companies where the two
functions are separate, the degree of interaction is very high. There are purchasing decisions
that are determined by questions of logistics, such as the purchase of large volumes to reduce
the cost of transportation. An example of logistics issues being set at the time of purchase
would be the case of a purchase from a supplier whose price includes transportation to the
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customer’s factory.

Owing to the proliferation of agreements between customers and suppliers, the

current trend is for the stock to be held on the supplier’s premises. This is usually the case in
situations of close cooperation with a single supplier with whom a long-term agreement has
been made. In a just-in-time system, for example, the stock is shifted onto the supplier by
making smaller orders more often. Inventory control systems are becoming increasingly more
sophisticated and it is vital that they be properly managed in order to reduce control actions
to a minimum.
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Logistics and production
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The size of warehouses, their location and the means of transport will be determined
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by the production system: whether goods are manufactured to order, to stock or according to
the just-in-time philosophy. For example, Harley Davidson, Hewlett-Packard and General
Electric have adopted just-in-time in their production system and have reduced the size of
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their stocks, and therefore the size of their warehouses, by more than 50%.

The means of supplying production should include alternative methods in the event
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of accidents or situations in which the usual means is not possible. The goal is to prevent the
production process from stopping, particularly in systems where this is very costly.
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Agreements with other transport companies or the use of alternative means of transport may
ensure supply in the event of a strike, bankruptcy, etc.

To obtain the potential benefits, logistics managers will have to be involved in

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setting production and corporate goals and will need a better understanding of the nature of
the demand for raw materials in the production process.

Logistics and the service chain

A good service to the customer means a prompt response, local presence, consistent
lead-times, a wide product range, consistency in services, and flexibility to allow orders to be
changed. All these aspects are closely related to the company’s logistics system. How we
define the type of service we wish to offer –width of product range and lead-time are the two
extremes– will directly determine the configuration of the logistics system.

In cases where the company does its own transportation, the task of installation is
often carried out by transport personnel who have been given the appropriate technical
training.

Sometimes the company tries to obtain information on logistics and customer

satisfaction through its salesmen, but normally part of this information is lost as it is
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conveyed upwards. Sales personnel are good at detecting what is important for the customer,
but have difficulty in detecting how the customer evaluates the logistics system.

A study carried out on four multinational companies operating in Europe concludes

that developing a logistics system in line with a certain service level can be seen as a five-
step process:

– Definition of the levels of service.

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– Measurement of these levels.

– Development of various alternative logistics configurations that ensure these

levels of service.

– Calculation of the cost of each configuration.

–
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Implementation of the optimal configuration.

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Things to be taken into account when designing a logistics system
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1.- The stage of the product’s life

– Introduction. The primary factor is flexibility. Demand is highly unpredictable.

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– Growth. Demand is now more predictable. Reliability of delivery is more

important than lead-time. Large quantities are purchased. The need for
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flexibility decreases.
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– Maturity. In this stage, logistics will depend on the company’s way of

competing: innovation, price, etc.
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2.- Customer and supplier policies

– If the customers follow just-in-time, they will tend to lower stock levels and
even eliminate stocks altogether. It will therefore be advisable to supply often
and in small quantities. The inefficiencies associated with this type of shipment
may lead us to seek an optimal quantity that minimizes transport costs. We will
react to the customer’s needs in accordance with the information shared.

– If service is the primary criterion for customers, a decentralized warehouse

system will be suggested, holding stock at various locations. This will mean
higher stock levels. Procedures will probably be flexible.

3.- Types of customer and supplier

– One very large customer or supplier. The company will normally have inhouse
capacity. The suggested distribution system is directly to the customer without
any intermediate stages or nodes. Procedures will be flexible, as it is more than
likely that the relationship with the customer will be based on cooperation.
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– A large number of small customers. The distribution chain will probably have
more links and intermediate levels, and a mixed transportation system will be
used in order to reach more places. It would be advisable to study whether it is
possible to consolidate so as to plan collections and deliveries.

– Long-term contracts with customers or suppliers. Transport can be optimized by

making the load as large as possible, provided the customer can hold stock.
Otherwise, it will no doubt have to be held on the supplier’s premises.
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– Short-term contracts. A flexible, fast-reacting system would be more suitable in

order not to lose sales opportunities.

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Thomas Foster, “Transportation quality program”, Distribution, Vol. 88, Issue 8, August
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Alan Williams, “Desired attributes of logistics managers and a learning hierarchy in

management education”, Logistics and Transportation Review (Canada), Vol. 26,
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Donald Bowersox, “The strategic benefits of logistics alliances”, Harvard Business Review,
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Erik Calonius, “Federal Express’s battle overseas”, Fortune, Vol. 122, Issue 14, December
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Robert Bowman, “The state of quality in logistics: AT&T, Union Carbide, StorageTek, Dow
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 IESE 13 693-012
University of Navarra PN-313-E

Perry Trunick, “Prepare for changes in European logistics”, Transportation and Distribution,
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Katrin Bernhardt, “Germany’s new packaging laws: The green dot arrives”, Business
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Issue 2, 1991.

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