The environment that companies do their business in is constantly changing

The environment that companies do their business in is constantly changing; examples of this are the customer service which has gone through an extensive development; the global area of performance and the integration of organisations in order to achieve the ultimate goal which is to satisfy the customers. But one of the most visible changes has been in the way which time has become a critical subject in management. Today product cycles are shorter than they used to be, customers and distributors take for granted just-in-time deliveries and end users are more willing to accept a substitute product if their first choice is not availably at once.
In the past a company’s capabilities have been to compete with the physical product and the functionality of the product and its quality. This is changing, since for a company to be an order winner, the offer has to include a service that is competitive. In an offer from a company today there is always a product and a service and the mix between these two will differ depending on the business. One important part of the service offered is activities that are related to logistics. The physical product is not as important as the services that surround the product and the effort of logistics service is needed to compete and to satisfy the customer.
For a company to stay competitive and to keep up with the development, the focus of logistics must shift. The focus of logistics has to adjust to the following:
From To
Cut costs Generate income
Satisfy customers Successful partnership
Product orientation Customer orientation
Focus on material flow Focus on information- and material flow
With the above focus in mind it is possible to develop solutions that are competitive to manage the material flow.
2.1.1 Logistics and Its Attributes
Logistics best practise is presented as a work in progress, subject to a continuous change based on the evolving nature. With the use of logistics management the goal is to link the marketplace and the operating activity business in such way that customers are serviced at higher levels and at a lower cost. According to Christopher with the use of a total systems viewpoint of logistics management (see Figure 2.1), the needs of customers could be satisfied through the coordination of the materials and information flows that extend from the marketplace, through the operation environment of the firm and to the suppliers. Figure 2.1 Logistics management process.

Source: Christopher, M., 1998.
Logistics management focus is to optimize flows within the organizations and to have a planning orientation that seeks to create a single plan for the flow of product and information through a business.
Stock and Lambert point out that information is not a process, but a key enabler of supply chain integration. Bowersox et al also point out that product flow always takes place only after information flows is initiated. Logistics is a functional silo within the companies, but it is also a bigger concept that deals with the management of material and information flows across the supply chain.
Christopher points out that it has to be kept in mind that even if logistics is described as an integrative concept that seeks to develop a system-wide view of the firm, it is still primarily a planning concept. The mission of logistics management is to create a one-plan mentality within the business.
Logistics in contrast to supply chain management is the work that is necessary to move and position inventory throughout a supply chain. Integrated logistics serves to link and synchronise the overall supply chain as a continuous process and is vital for effective supply chain connectivity.
Over time there has been a growing recognition that it is through logistics and supply chain management that the twin goals of cost reduction and service improvement can be realized. The pipeline can, with better management, serve customers more effectively, at the same time the costs that deliver that service are reduced. To study logistics, there has to be a basic understanding of supply chain management. The supply chain decisions establish the operating framework and logistics is performed within this framework.
Logistics is the key conduit of product and service flow within a supply chain arrangement. Logistics can be seen as part of the overall supply chain challenge and often the terms logistics and supply chain management are used interchangeably, although Harrison and van Hoek also pinpoint that it has to be kept in mind that logistics is a subset of supply chain management.
Logistics has always embraced the total system view and flow oriented aspect. On the other hand, supply chain embraces the whole chain with internal and external customers and therefore must the definition of logistics to be complete. Service has to be included since this has become more significant for the product offered by a company. Surrounding and added services constitute a larger and integrated part of delivered physical product today and should therefore be included in the material flow. With this understanding of supply chain, logistics is only a part of supply chain management.
“Supply chain management is the integration of key business process from end user through original suppliers that provides products, services, and information that add value for customers and stakeholders.”
This is a definition of Supply Chain Management and it is much broader than the definitions of logistics. The most important difference is the management of the key business and they are: customer relationship management, customer service management, order fulfilment, manufacturing flow management, procurement, product development and commercialization and returns (see Figure 2.2). In addition to these key business processes is the product flow and information flow that take place in a supply chain. Supply chain management has been re-conceptualized from integrating logistics across the supply chain to integrating and managing the key business processes across the supply chain. This states that logistics management is only a part of the supply chain management.
Figure 2.2 Supply chain management: Integrating and managing business processes across the supply chain.

Source: Stock, J. and Lambert, D., 2001.
Authors used in this thesis tend to use several different subjects when explaining what attributes logistics have. In the end, the summary is that logistics’ most significant attribute is probably that it is cross functional, it crosses boarders within the company and also crosses barriers to other companies. It is probably because of this cross functional attribute that definitions of logistics often include a definition that considers the links to the supply chain. It is easy to use logistics and supply chain interchangeably, but as it has been pointed out, logistics is a subset of the supply chain. Supply chain is concerned with key business processes within a company and logistics is primarily concerned with information and material flow. The cross functional attribute also makes it difficult to apply a system view on logistics, and therefore it is important for an organisation to have a strategy for logistics.
2.1.2 Flows in Logistics
Earlier in the chapter logistics has been described through its attributes and logistics is concerned with the flows within the chain. The flows of logistics are monetary, information, material and resources. Monetary flow is concerned with invoicing and payment, resource flow represents the resources that are needed to move the material within the chain and the material flow is the goods to be moved. The information flow is the initiator for both monetary flow and material flow. In this thesis Hogström and Grigorjev will focus on material and information flow since the information flow is the initiator for material flow, and therefore these flows are in focus and explained below.
2.1.2.1 Material Flow
The material flow represents the supply of product through the network in response to demand from the next organisation. The issue here is how long does it take to get the product through the various stages from one end of the chain to the other. The focusing on time is important here because it measures how quickly a given network can respond to demand from the end customer. Often it is difficult to see where the flow starts in the chain and where it ends. The negative effect of this is the build-up of inventory and the slow response to the demand of end customer.
Therefore there are different strategies for managing inventory and the material administration, strategies for inventory will be further discussed in section 2.3. Normally material flow always goes from supplier to customer except when there exist reverse flow. Bowersox et al prefer to call it inventory flow, this is probably referring to finished goods since business discussed are often manufacturing or retail business.
2.1.2.2 Information Flow
Information is a collection of facts that is organized in such way that they have additional value beyond the value of the facts themselves. Data on the other hand consist of raw facts, such as an employee’s name and number of hours worked in a week, inventory part numbers or sales order. The value of information is directly linked to how it helps decision makers achieve their organization’s goals.
Today the information flow within the logistics has become vital as, this flow enables chains to respond in real time with accurate data. Companies today look at information flow as an asset, since it is not possible to have efficient and reliable material flow without it. The material flow cannot be isolated from information flow. There are strong links between the physical flow and the information that flows both upstream and downstream. To manage and communicate a material flow today, IT is necessary. But an information system is not only IT solutions but also other communication and data processing that are linked to material flow.
2.1.2.3 Reflections regarding Material and Information Flow
There is no doubt that information flow is important and it is important to evaluate what kind of information adds value to the particular logistics system in focus. The ability to change data into useful information is essential; otherwise it will only be data. The term information is often used as if it is clear to anyone what information is, but this is not always the case. To transform data into information that is of no use only costs money. Therefore the companies or departments within a chain have to agree about what kind of information adds value before taking decisions on what information should be produced and shared.
In Christopher’s discussion concerning material flow and information flow it has to be noticed that the information flow is concerned with requirements. The flow is only going in one direction and is concerned with customer requirements. Harrison and van Hoek agree with Christopher about material and information flow and that the direction of information flow is from customer to supplier. Instead of calling it requirements, Harrison and van Hoek refer to it as demand.
According to Mattsson 2002 there is also an information flow in the other direction that is concerned with the issue of what is possible to obtain. Mattsson 2002 claims that it is not just the supplier who needs different types of information regarding requirements. Customers also need different information about what is possible to obtain in the struggle to be able to reach a shorter reaction time to market. Mattson 2002 also consider the monetary flow, as one of the logistics flows, and this is often invoicing and payment.
To Lumsden 1998 logistics is about material flow and the activities and the system that are linked to the material flow. Lumsden 1998 does not specify what activities these might be, but he says that material flow cannot be isolated from the flow of information and there are several strong links between the physical flow and the information that flows both upstream and downstream.
Logistics includes all the activities to move product and information to, from and between members of a supply chain according to Bowersox et al. Within the context of supply chain, Bowersox et al refers to five critical flows: information, product, service, financial and knowledge. Logistics is the primary conduit of product and service flow within a supply chain arrangement and the process of logistics is viewed in terms of two interrelated flows and that is information and inventory.
What is common for all the authors used in this thesis is the material flow and information flow. The difference between the other flows is linked to the perspective the authors use when writing about logistics. The main difference is how they consider the flow of information and in what direction the flow goes. This is probably more linked to what levering the supply chain has reached and how closely the participants in the chain work. In the beginning it is probably a onedirection flow, and when the co-operation is more trusting and closer, the information flow will extend between the partners within the chain. The authors mentioned above point out that information has over the years become a vital part of the flow and sometimes even more important than the material flow. The enabler of this is the development of information technology.
2.1.3 Logistics Information Flow
The stream of data in different directions with variable contents between various databases (departments) within a company is defined as information flow. According to Stair and Reynolds, data for a logistics management information system can come from many sources. At the same time, Stock and Lambert define the most important sources of data for the common database, which are the order processing system, company records, industry data, and management data (see Figure
2.3).
Figure 2.3 The logistics information flow.

Source: Stock, J. and Lambert, D., 2001.
Moberg et al identify two types of logistics information such as operational and strategic information. Operational information typically encompasses short-term, quantitative information about daily logistics/sales activities or status information on orders and inventory levels. It is primarily used to reduce order cycle times and inventory levels and to improve customer service. In contrast, strategic information covers long-term issues related to the firm’s marketing, logistics, and other business strategies. This long-term, qualitative, and sensitive information is primarily used to improve collaboration among supply chain partners and plan future logistics practices based on upcoming strategy changes.
Moberg’s et al definition of operational and strategic information is almost equal to Bowersox’s et al characterization of logistics information utilisation in two major logistics processes:
Planning/coordination: the overall purpose of planning/coordination is to identify required operational information and to facilitate supply chain integration via strategic objectives, capacity constraints, logistics requirements, inventory deployment, manufacturing requirements, procurement requirements, and forecasting.
Operations: accurate and timely information to facilitate logistics operations. Operational information is required in six related areas: order processing, order assignment, distribution operations, inventory management, transportation and shipping, and procurement.
As a result, Bowersox et al name four reasons why timely and accurate information has become more critical for effective logistics systems’ design and operations:
? Customers perceive information about order status, product availability, delivery schedule, shipment tracking, and invoices as necessary elements of total customer service.
? With the goal of reducing total supply chain assets, managers realize that information can be used to reduce inventory and human resource requirements.
? Information increases flexibility with regard to how, when, and where resources may be utilized to gain strategic advantage.
? Enhanced information transfer and exchange capability utilizing the Internet is changing between buyers and sellers and redefining the channel relationships.
The authors mentioned above emphasize the importance of perceived information for logistics operational and strategic planning and performance. The major problem is to gather useful information from different sources within the company and adapt it for regular utilization. Quite often, companies have multiple information systems or databases operating in each department. Therefore, there is the additional challenge of how to connect all the systems in order to achieve a higher degree of information visibility and accessibility in the internal supply chain.
2.2 Ways of Mapping Processes
Process mapping is the visualising of the activities and objects of a process, and how their relationships are carried out. To map a process is to create a model of a process. In this section Hogström and Grigorjev will go through different ways of business process mapping according to three different approaches presented by Harrison and van Hoek, and Mattsson. Harrison and van Hoek focus on time the activity takes. Mattsson 2003, on the other hand, points out that the time measured could also be the passing through time; he also suggests a process mapping that considers what departments or persons carry out the activity. Before the description of the possible ways of process mapping, an explanation of process definition is required.
2.2.1 Business Process
Business process is defined as a coordinated sequence of activities that has its purpose to transform some kind of input to output. The input could be in form of information, material or payments. The most typical characteristic for business processes, especially core processes that add value to the products and services, is that they reach across functional boundaries. Process perspective means organizing resources and responsibilities around core business processes instead of around tasks and functions.
Processes often include customers and suppliers, although many companies have not reached the level to include external participants, but this does not mean that a process should not be mapped. Both Mattsson 2002 and Lumsden 1998 define process as either with internal or external customers. The next activity in the process should be regarded as a customer and should also be treated this way.
To make supply chains more effective, there is a need to improve the conditions regarding the exchanges and flows between companies. Due to the conditions that companies today meet on the market, a process oriented view has influence in the way they organise and conduct their business.
2.2.2 Processing Mapping When Time is in Focus
The purpose of supply chain mapping is to give transparency to the processes within the supply chain. When a supply chain mapping is taking place it is the actual process that requires focus, not result. The key is to track one order, one product, or one person through the process with the respect to time. A map is a mirror of what takes place during a given time period and during this time period the actual time that it is observed is recorded. By mapping the process, key operations are still visible, but the subprocesses that often consume time and generate the greatest inefficiencies are revealed at the same time. This causes solutions to problems to be generated and thus the supply chain is improved.
Create task weakness: Before the mapping process, the supply chain processes that cross all functions of the organisation need to be identified. This stresses the importance of the key functions to be represented.
Select the process to map: To make the mapping process feasible, identify the core processes within the organisation and the time they take before deciding on the priorities for detailed mapping. When selecting the process, make sure that there is a generic customer or group of customers that the process serves.
Collect data: The most effective way to collect data is simply to follow the item through the process, also referred to as walking the process. An actual component or order will be followed through all stages that are included in the process. It is important to identify those individuals who are actively involved in the process and really knows what is happening. Each movement of the item should be described with respect to time.
Distinguish between value-adding and non-value-adding time: Value-adding time is time when something takes place on the item that the end customer is willing to pay for. It is important that the definition of value-adding takes place within the organisation and the definition should be associated with the overall business strategy. When there is an understanding of the value-adding criteria at the strategic level, these criteria can be translated into value-adding criteria at an operational level. There are three criteria that are characterised for value-adding time:
? If the process or elements physically change the nature of consumable item.
? If a change to the consumable item produces something that the customer values or cares about and also is willing to pay for.
? If the process is right the first time, and will not have to be prepared in order to produce the desired result, that is valued by the customer.
The non-value adding activity can be split into four categories: delay, transport, storage and inspection.
Construct the time-based process map: The overall purpose of the time-based process map is to represent the data that is collected clearly and concisely. By doing this the critical aspects of the supply network can be communicated in an easily accessible way. If the process can be represented on a single piece of paper the members of the project can easily see the issue. To extract the relevant data, it is useful to sketch a flow diagram so that the linkages and dependencies between steps can be clarified before constructing the map. The flow diagram can be used to estimate the total time that the business process consumes. Figure 2.4 Example of process map.
Step Description Symbol Time Notes
1 Machine complete O 1:37
2 Inspect ? 0:45
3 Wait transport D 5:53
4 Transport to heat treat ? 0:08
5 Wait heat treat D 3:34
6 Heat treat O 4:15
? – transport ? – store O – operation ? – inspect D – delay
Source: Harrison, A. and van Hoek, R., 2002.
Solution generation: When the time-based process map has been produced, the opportunities for improvement are generally obvious. The next step is to collect ideas and categorise causes of non-value-adding activity by using problem-solving approaches.
2.2.3 Process-Analysis and Function-Flow-Schedule
The process or processes that are in focus for redesign ought to be defined from the beginning to the end and the customers of the process should also be known.
The next step with the rationalisation of the process is to map out and describe how the process/processes look at the present moment. This will always be a subject for discussion, but even if the process is known, the knowledge about how the total process functions is often poor. In a functional organisation every individual will have good knowledge about the activities that take place within that department. But since processes are cross-functional, the case is often that no one at the company has the knowledge about how the different processes look. Since processes also cross between companies, personnel from both supply and customers should participate in the work of analyse and redesign.
There are different means that could be used when mapping out the process, but below there will be a presentation of two: process-analyse-schedule and functionflow-schedule.
2.2.3.1 Process-Analysis-Schedule
The purpose of process-analyse-schedule is to map out and to document in what order the different activities within the process of the study occur. This is of great value when there is a need to study the time and the cost for carry out different activities. The figure below gives an example how the schedule might look. Figure 2.5 Process-analysis-schedule
No. Activity decsription Time Cost Type of activity
1
2
3
4
5
Source: Mattsson, S-A., 2002.
In the form the processes are noted in the order that they are carried out. The time it takes is noted and also the cost. The time it takes could be of two different kinds, the actual time it takes to do the activity or the passing through time for the activity at each department. In the form there is also space to note what kind of activity it is. For example, it could be that something is actually done, or it is waiting, or in transport or in a warehouse. With help from the noted time required and the cost, the total cost and total time required can be calculated for the process as a whole.
2.2.3.2 Function-Flow-Schedule
The function-flow-schedule not only shows the activities that are carried out but also in what order they are carried out. The schedule also shows who carries out the activity. Who in this case could be an individual or a department. If this is a schedule of a supply chain process, this will also include in what company the individual or department is to be found. Figure 2.6 Function-flow-schedule.
Department A Department B Department
C Department
D Department E Department F
Activity 1
Activity 2 Activity 3 Activity 4
Activity 5
Activity 6 Activity 7
Activity 8 Activity 9
Source: Mattsson, S-A., 2002.
The function-flow-schedule is particularly useful when there is a need to map out how many individual and departments are involved in a process and whether the activity is executed in the different departments. This is useful when there is a wish to rationalise the process by redistributing and/or combining activities between different individuals.
When all of the activities and connections between the activities are mapped, the processes should be critically analysed. A way to do this is to systematically question the activities by asking the following questions:

What? The purpose of the activity Why must this activity be done
Where? The place for that particularly activity Why must is be done at this particularly place
When? The sequence in what the activity is performed Why must it be performed at this moment
Who? The individual who carry out the activity Why must it be this individual
Why must the activity be carried
How? The way the activity is carried out
out in this way
The overall purpose is to ask these questions for each of the activities and try to eliminate, combine, change or simplify the different activities that are carried out in the process that should be rationalised.
Walking a process is necessary if an investigator wants to find out where does the process begins and ends. The different models described above are more or less the same. Harrison and van Hoek’s model and the Process-Analyse-Schedule by Mattsson identify activities within the process, time, type of activity and cost.
There is a possibility to combine them and add the column with costs used in the
Harrison and van Hoek model. The third approach, Mattsson’s model FunctionFlow-Schedule, is used to illustrate how many departments or persons are involved in a process. It is important to realise that the activities in the same column are not carried out simultaneously. The Function-Flow-Schedule model only highlights the number of departments or persons involved in the process. By using the model, in the way it is proposed above, it could give a false picture of the situation. Therefore it could be a better to illustrate the process according to the adjusted model below:

Dep. A Dep. B Dep. C Dep. D Dep. D Dep. D Dep. E Dep. E Dep. D
Act. 1
Act. 2
Act. 3
Act. 4
Act. 5
Act. 6
Act. 7
Act. 8
Act. 9
2.3 Inventory Management
The Institute of Logistics and Transport has the following definition of inventory management:
“The effective management of stock, materials, parts and finished products, including additions and deletions (i.e. control of movements in and out). Essential for determining capital investment returns and viability of stock levels and for the avoidance of opportunity cost (i.e. money tied up in stock that could be better used).”
In theory, the best solution for a company in servicing its customers would be to locate an inventory in each facility that is closest to the customer. There are not many companies that could afford such a luxurious inventory commitment because the costs are discouraging. Therefore, according to the definition, the objective of the effective inventory management is to accomplish desired customer service with the minimal inventory level followed by lowest tied up capital in inventory.
Lumsden states that having an inventory does not have to be wrong, as long as it is dimensioned from established criteria. However, optimizing a storage is something done with respect to a shorter time perspective. In the longer perspective, optimizing is more about how to work with the conditions in order to minimize the inventory. Safety stock can be optimized from formulas, but should in the long term be minimized by removing insecurities, e.g. by choosing more reliable suppliers.
On the other hand, Christopher notes that the existence of an inventory can be sign that the logistics process is not stable enough. Lumsden and Christopher illustrate the inventories function with help of Japanese manufacturing philosophy, “The Japanese Sea”, which was developed from the concept of removing all inventories in order to identify problems in the company’s logistics processes. In other words, lowering the inventory levels discloses problems that were previously hidden.
Figure 2.7 The Japanese Sea: Inventory hides the problems

Source: Christopher, M., 1998.
The inventories are still used among the companies and, of course, the companies do not have to hustle to lower or/and eliminate its inventories. It is almost impossible as well as dangerous for a company to make an effort to solve all previously hidden problems immediately. Obviously, the cautious step-by-step process of lowering the inventory levels in combination with the total logistics cost analysis would be the best solution in this situation.
It is not a mistake to use inventories. However, the utilization of inventory demands effective inventory management with defined inventory policy, order quantities, and inventory service levels. The objective of inventory management is to improve the corporate profitability and increase customer service level with minimal tied up capital in inventory. However, the inventory management strategy has to be seen in the greater perspective of the total logistics cost concept (see Section 2.4.2.) with possible negative consequences for other logistics costs. Furthermore, in the longer perspective, a company has to try to remove insecurities in the supply chain by establishing collaboration with strategic suppliers.
2.3.1 Purpose of inventory
Waters points out that the main purpose of inventories is to act as a buffer between supply and demand. They allow operations to continue smoothly and avoid disruptions. Waters names some other reasons for holding inventories:
? To act as a buffer between different operations
? To allow for demands that are larger than expected, or at unexpected times
? To allow for deliveries that are delayed or are too small
? To take advantage of price discounts on large orders
? To buy items when price is low and expected to rise
? To buy items that are going out of production or are difficult to find
? To make full loads and reduce transport costs
? To give cover for emergencies.
2.3.2 Types of Inventory
There are different approaches to classifying inventories. Lumsden 2003 categorizes the inventories that are the process-based (storages, component inventory, consumption material and work in process), the flow design-based inventories(buffer, process and transportation) and, finally, the function-based inventories which reminds us of Stock and Lambert classification. In this paper, the inventories will be described according to Stock and Lambert from a function-based point of view.
Inventories can be categorized into the following types, signifying the reasons for which they are accumulated:
Cycle inventory is inventory that results from the replenishment process and is required in order to meet demand under conditions of certainty – that is, when the firm can predict demand and replenishment times (lead-times) perfectly.
In-transit inventory inventories are items that are en route from one location to another. They may be considered part of cycle inventory even though they are not available for sale and/or shipment until they arrive at the destination.
Safety or buffer stock is held in excess of cycle inventory because of uncertainty in demand or lead time. The notion is that a portion of average inventory should be devoted to cover short-range variations in demand and lead-time.
Speculative inventory is inventory held for reasons other than satisfying current demand. For example, materials may be purchased in volumes larger than necessary in order to receive quantity discounts, because of a forecasted price increase or material shortage, or to protect against the possibility of a strike.
Seasonal inventory is a form of speculative inventory that involves the accumulation of inventory before a season begins in order to maintain a stable labour force and stable production runs.
Dead inventory is the set of items for which no demand has been registered for some specified period of time.
2.3.3 Inventory management performance measurement
To be able measure inventory management performance, Hogström and Grigorjev will apply inventory turnover rate and inventory service level.

2.3.3.1 Inventory turnover rate
The turnover rate of the storage is defined as the number of times per year storage is turned over. According to Lumsden, there are different ways of calculating Inventory turnover rate that depend on institutional to company dependent relations.
Hogström and Grigorjev will apply estimating Inventory turnover rate, which is provided by Lumsden since it covers tied up capital:
Turnover
Inventory turnover = Equation 2-1
Tied up capital
2.3.3.2 Inventory Service Level/Fill Rate
There are different names for fill rate in the logistics literature, although all of them have a similar characterization for inventory management. Fill rate is directly associated with service level. Lowe states that service level is the desired probability that a demand can be met from inventory which can be expressed in a number of ways, such as in case of inventory management percentage of units demanded which are met from inventory. Stock and Lambert use the term “fill rate” which means the percentage of units that can be filled when requested from available inventory and thus affect customer service level. Bowersox et al define service level as a performance target that is measured in terms of order cycle time, case fill rate, line fill rate, order fill rate, or a combination of these. Christopher associates the customer service level to additional inventory required to satisfy customer demand. Lumsden characterizes the service level concept as relation between probability for stockout and service level.
One way of increasing service level without increasing the number of items in safety stock is to substitute transportation costs for inventory carrying costs by using faster and more reliable modes of transport to improve customer service. Another possibility is to distinguish the differences in demand variations with each product and set inventory levels according to product categories.
2.3.4 Inventory Carrying Costs
Inventory carrying costs, the costs associated with the quantity stored, include a number of different cost components and generally represent one of the highest costs of logistics.
Capital costs. The company’s cost of capital – the rate of return that could be realised from some other use of the money – should be used to accurately reflect the true cost involved. In companies experiencing capital rationing, the interest rate (which is the minimum rate of return on new investments) should be used as the cost of capital.
In order to calculate the company’s total cost of capital, the calculation should cover the tied up capital during different production stages, such as safety stock, average cycle inventory and cost for inventory in transit:
Cost of capital = Cycle inv.× +I Safety inv.× +I Inv. in transit ×I Equation 2-2
Then the calculation of the holding costs for cycle inventory is:
Q
Holding costs for cycle inventory = ×C Equation 2-3 2
where, Q- the order quantity, I – interest rate, C – cost per unit
To calculate the cost of holding inventory in transit in which the following formula can be applied:
Inventory in transit = D×T Equation 2-4 where, D- the average flow per time unit (the order quantity times number of orders), T – transit time
Inventory service costs that include insurance and taxes on inventory.
Storage space costs which include those warehousing space-related costs that change with the level of inventory.
Inventory risk costs including obsolescence, pilferage, movement within the inventory system, stockout costs and damage.
According to the problem definition, Hogström and Grigorjev will focus only on the calculations of tied up capital and capital costs for inventory, especially those of cycle and safety stock.
2.3.5 The Importance of Cash Flow
If a company receives or gives credit the tied up capital is displaced, and the inventory has not changed, but regardless of the inventory level, the tied up capital is not affected until cash flows out or in. When a company gives one month credit it has to tie up that capital for one more month. On the other hand, if the company is given one month credit and does not by itself give any credit, the capital needed is reduced by the same amount. The importance of credit time often is not valued enough. There is a good reason for a company to investigate the credit a company gives and gets.
2.3.6 Inventory Management under Uncertainty
Nowadays companies operate in rapidly changing business environment. New opening markets, altering governmental regulations, increased competition on the markets, changes in customers’ buying behaviour and other macro factors affect companies’ way of doing business.
The issue of coping with uncertainty is important as it exists in a realistic operating environment. Uncertainty exists in the production system in many different ways.
The demand for the product and (replacement) parts is typically forecast, and as a result has a certain degree of uncertainty with respect to both the quantity demanded in a particular time period, and the timing of the quantity demanded. The uncertainty in the quantity demanded is obvious; however, there also often exists an uncertainty in timing. Another major source of uncertainty exists at the supply (purchased items) level. This could again occur in the form of quantity, timing, or both.
Stock and Lambert believe that management has the option of either maintaining additional inventory in the form of safety stocks or risking a potential loss of sales revenue due to stockouts.
Hogström and Grigorjev have carried out a literature search about buffering against uncertainty and will introduce below one of the most common technique for decreasing insecurities in inventory management – safety stock technique.
2.3.6.1 Safety Stock Calculations
The calculation of safety stock level that is necessary to satisfy customer demand during a replenishment cycle can be determined by computer simulation or statistical techniques. The statistical technique for variations of demand, and replenishment cycle, and additionally, for only variations in demand are introduced below.
Safety stock calculation in case of demand variations and constant replenishment cycle
According to Lumsden, in case of constant replenishment cycle lead-times or lack of statistical data for suppliers’ performance, the calculation of safety stock level with variations in demand can be expressed as:
SS = Z?s R Equation 2-5
where
SS – the safety stock level, Z – the safety factor, ?s – the deviation of daily sales
(demand), R – replenishment cycle (lead-time)
The standard deviation formula is:
? fd2
?s = Equation 2-6 n?1
where f – frequency of event, d – deviation of event from mean, n- total observations.
There is no need of any safety stock if the deviation is decreasing the demand since it will be covered by the normal cycle inventory, i.e. in 50% of all cases. The service level concept might then be expressed as:
Service level = SL = ?1 probabilty for stockout Equation 2-7
The meaning of this is that a service level of up to 50%, i.e. that every second customer order cannot be supplied, does not need any safety stock. The likelihood of a customer accepting this low service level is small, at least if he is an external customer with any other alternative. Hence, a safety stock has to be created to increase the service level.
According to Lumsden 2003, the safety factor is only connected to the percentage of the demand that is above the safety stock, i.e. which defines the stockout and thereby also the service level. A progressively larger safety stock is required to reach a higher service level or a possibility to satisfy orders. The costs to keep a high level service do not increase proportionally. A one percent improvement of the service level is far more expensive the higher service level the company has.

Safety stock calculation in case of demand and replenishment cycle variations
In contrast with the previous calculation, additional data about variations in replenishment cycle lead-time is needed. Once the data are collected it is possible to specify the safety stock requirements by using the following formula:
?c = R(? ?s2)+S2( R2 ) Equation 2-8
where ?c – units of safety stock needed to satisfy 68% of all probabilities (one

standard deviation), R – average replenishment cycle, ?s – standard deviation of

daily sales, S – average daily sales, ?R – standard deviation of the replenishment cycle.
The calculation of the required safety stock level is:
SS Z= ×?c Equation 2-9
where SS – safety stock in units, Z – the safety factor, ?c- the combined standard deviation.
2.4 Gaining Competitive Advantage
Organisations that will be leaders in the markets of the future will be those that have sought and achieved the twin peaks of excellence; they have gained cost leadership and service leadership. The underlying philosophy behind the logistics concept is that of planning and co-ordinating the materials flows from source to user as an integrated system rather than managing the goods flow as a series of independent activities. Under a logistics management system the goal is to link the marketplace, the distribution network, the manufacturing process and the procurement activity in such way that customers are serviced at higher levels and yet at lower cost.
Today, it is generally accepted that the need to understand and meet customer requirements is a condition for survival. For a company to meet customers’ requirements it is not possible for functions within a company to act independently of each other. Leading-edge companies include supply-side issues in the development of their strategic plans (the concept of strategy is explained further down in this chapter). The cost of purchased materials and supplies is a significant part of a total costs in most organisations, but there is also a major opportunity for leveraging the capabilities and competencies of suppliers through closer integration of the buyers’ and suppliers’ logistics processes. Before going into how to achieve an integrated supply chain, the concept of functional and process perspective of business processes, the total cost concept and time-based management will be explained below.
2.4.1 Competing Through Logistics
Companies today can no longer act as an isolated and independent entities in competition with other similarly stand-alone organisations. In the past the ground rules for success were strong brands backed up by large advertising budgets and a selling that was aggressive. Companies today must recognise that the competition today is through their capabilities and competencies. By managing their core processes better than competitors manage theirs, organisations can create superior value for customers and consumers. The core processes include such activities as new product development, supplier development, order fulfilment, and customer management. If an organisation can perform these activities in a more costeffective way than the competitors, the organisation will gain the advantage in the marketplace.
Stock and Lambert believe that just like a good product, promotion, and/or pricing strategy, logistics can be a source of competitive advantage for a firm. Competitors can develop competing products in a short time but logistics is difficult to duplicate. Many organisations have recognized that logistics competency holds the key to developing or maintaining continued business success.
The researchers cited in this thesis are all convinced that there is a possibility of achieving competitive advantage through logistics. They also states that is difficult to achieve this competitive advantage by themselves; it has to be reached in a network or chain, together with other companies who are world class in their respective areas. The key enabler to this is information and to what extent companies share information between them. The road to reach a level of the supply chain where the information is transparent is long. Not all companies reach this level, but those who have developed world-class logistics competency have the benefit of enjoying competitive advantage as result of providing important customers superior service. The literature refers to supply chain as it exists within all companies and information is shared between partners. This if far from the reality. Many companies are still struggling to streamline and adjust their activities within the company in order to reach a competitive advantage .
2.4.2 The Total Cost Concept
Lambert and Stock have a broad perspective on total logistics costs. Total cost analysis is the key to managing the logistics function. One of major goals of the organisation should be reducing the total costs of logistics activities rather than focusing on each activity in isolation. Reductions in one cost invariably lead to increases in the costs of other components. Effective management and real cost savings can be accomplished only by viewing logistics as an integrated system and minimising its total cost given the firm’s customer service objectives.

Figure 2.8 Logistics’ role in the economy and the organisation.

Source: Stock, J. and Lambert, D., 2001.
The major cost categories are customer service, transportation, warehousing, order processing, and information, lot quantity, and inventory carrying.
2.4.2.1 Customer Service Levels
Customer service represents the output of the logistics system and the place component of the firm’s marketing mix. It is a measure of the effectiveness of the logistics system in creating time and place utility for a product. The sum of the expenditures for such logistics activities as transportation, warehousing, order processing and information systems, production setups and purchasing, and inventory management can be viewed as the company’s expenditure for customer service.
There are various performance metrics for Customer service, Bowersox et al. name some of them: fill rate, stockouts, shipping errors, on-time delivery, cycle time, response time to inquiries, response accuracy and complete orders.
The best approach is to determine desired levels of customer service based on customers needs, and to consider how those needs will be affected by expenditures on the areas of the marketing mix. Because each of the other five major logistics cost elements work together to support customer service, logistics managers need good data regarding expenditures in each category.
2.4.2.2 Warehousing Costs
Warehousing costs are created by warehousing and storage activities and by the plant and warehouse site selection process. Included are all of the costs that vary due to a change in the number or location of warehouses.
There is no single best approach that a firm can pursue in warehouse productivity measurement. Management action is determined by a variety of factors, such as customer service levels (e.g., shipping performance, error rates, order cycle time); inventory accuracy (e.g., correct quantities of each SKU at all warehouse locations); space utilisation (e.g., the right inventory, square foot or cube utilisation of facilities), and labour productivity (e.g., throughput rates).
2.4.2.3 Order-Processing/Information Systems Costs
The order processing system can affect the performance of the logistics function in two major ways. First, the system can improve the quality of the management information system by providing such data as customer names, location of customers, items demanded by customer, sales by customer, sales patterns, order size, and sales data for the company’s sales forecasting package. Second, the customer order is the message that sets the logistics function in motion. The speed and quality of the information provided by the order processing system have a direct impact on the cost and efficiency of the entire logistics process. Slow and erratic communication can lead to lost customers or excessive transportation, inventory, and warehousing costs. Implementation of the latest technology in order processing can lead to significant improvements in logistics performance.
Order processing and information systems costs are related to activities such as processing customer orders, distribution, communications, and demand forecasting. Investing in order processing and information systems is extremely important to support good customer service levels and control costs. Order processing costs include order transmittal, order entry, order verification, order handling, and related internal and external costs such as notifying carriers and customers of shipping information and product availability.
2.4.2.4 Transportation
Expenditures that support transportation can be viewed in many different ways, depending on the unit of analysis. Cost can be categorised by customer, by product line, by type of channel, by carrier, by direction (inbound versus outbound), for example. Costs vary considerably with volume of shipment, weight of shipment, distance, and points of origin and destination. Costs and service also vary considerably with mode of transportation chosen.
2.4.3 Cost-based versus Time-based Management
The traditional way to improve efficiency and effectiveness within a company has been based to a large extent on cost reduction concepts and strategies. However, according to Mattsson 2000, focusing directly on time instead of on cost is quite a different approach to making companies more efficient and more competitive. Using time-based management, companies reduce costs indirectly through compressing lead times. Faster inventory turnover and lower overhead costs are typical consequences when lead times are compressed by eliminating breakdowns, delays and various kinds of waiting times.
Focusing on lead time also means improved flexibility and faster response time and it provides leveraging effects on profits possibly not obtained by cost-based management. Focusing on lead time is also more oriented towards customers and customer service than toward internal efficiency, which is more typically the case with the cost-based management approach.
Experience gained in companies around the world has repeatedly shown that the results achieving by applying time-based management are significant. As time is compressed:
? Costs are reduced and productivity is increased;
? Prices can be increased;
? Customer service and profitability is improved;
? Capital tied up in inventory and work-in-process is reduced;
? Quality is improved.
2.4.4 Strategy
Strategy is defined as follows:
“Strategy is the direction and scope of an organisation over the long term, which achieves advantage for the organisation through its configuration or resources with a changing environment and to fulfil stakeholders’ expectations.”

2.4.4.1 The Importance of Planning
Mission statements provide the foundation from which the company develops strategies, plans and tactics. It also provides direction and control for tactical plans and daily operations.
As corporate mission statements serve to provide the starting point for developing corporate goals and objectives, the logistics statements will provide direction for developing business strategies. The components of a corporate mission statement or logistics mission statement are only one element of a firm’s total corporate mission.
In the absence of planning, managers must spend an disproportionate amount of their time as fire fighters reacting to crises rather than anticipating change and developing strategies to deal with it.
2.4.4.2 Levels of Strategy
Corporate-level strategy is concerned with the overall purpose and scope of the organisation and how value will be added to the different business units of the organisation.
Business unit strategy is about how to compete successfully in particular markets. This concerns how advantage over competitors can be achieved; what new opportunities can be identified or created in markets; which products or services should be developed in which markets; and the extent to which these meet customer needs in such way as to achieve the objectives of the organisation. Strategic business unit (SBU) is a part of an organisation for which there is a separate external market for goods or services that is different from another SBU. Because of this separate external market there is a need for different strategies.
Operational strategies are concerned with how the component parts of an organisation deliver effectively the corporate- and business-level strategies in terms of resources, processes and people. In most businesses, successful businesses strategies depend to a large extent on decisions that are taken, or activities that occur at the operational level. The integration of operational decisions and strategy is therefore of great importance.
2.4.4.3 Logistics Strategy
Logistics strategic planning has been defined as follows:
“Unified, comprehensive, and integrated planning process to achieve competitive advantage through increased value and customer service, which results in superior customer satisfaction (where we want to be), by anticipating future demand for logistics services and managing the resources of the entire supply chain (how to go there). This planning is done within the context of the overall corporate goals and plan.”
When overall corporate strategies and marketing plans have been determined, the logistics planner must evaluate the basic alternatives and recommend the system configuration that satisfies customer requirements at the lowest total cost. The process must begin with identifying and documenting customer service goals and strategies. Management can use a customer service survey to determine the needs and requirements of the firm’s customers. The plan must consider the specific requirements of customers, competitive service levels, changing environmental conditions, and the amount of service that the company is willing to offer. It is not possible to design an efficient and effective logistics system without first establishing the firm’s customer service objectives.
2.4.5 Achieving an Integrated Supply Chain
Before describing the evolution of how to reach an integrated supply chain the concept of functional and process perspective has to be understood.
2.4.5.1 Functional Perspective
The traditional way to organise a company is through functions due to the characteristics of activities and responsibilities. One of the main principles behind the practice of organising through functionality is from input and consumption of resources.
When a company is organised through function it is more focused on effective administrative management of the company’s resources than creating value adding flow from delivery of material to the company and to delivery of product to the customer. This leads to the fact that many different participants are involved in every chain of activity, which in turn leads to long run through time and a lack of flexibility and ability to adjust to changes in the market.
2.4.5.2 Process Perspective
Lumsden 1998 and Mattsson 2002 pinpoint what are common for processes: a process consists of activities, and the aim of the process is to create value and there is a customer who is the target for these value adding activities. The process appears often as cross-functional flows of part-processes that overcome the gap between the functional units of an organisation. Process-view creates awareness of the customer, the product, the information flow and the resource consumption and more clearly point out the efficiency of the organisation in focus.
Since a company get its income from customers by delivering products, the most practical way to organise would be through the output instead of input. This means that a company should organise its activities after products and material flow with focus on delivery to customers.129

2.4.5.3 The Evolution of Achieving an Integrated Supply Chain
The concept of supply chain management is in fact no more than an extension of the logic of logistics. Organisations do not go from managing logistics and to being a supply chain. The figure below suggests that there is in effect on evolution in integration.
Figure 2.9 Achieving an integrated supply chain.

Source: Christopher, M., 1998.
There is an evolution of integration from stage 1 which indicates a complete functional independence where each business function does its business in complete isolation from the other business functions. A good example of this is where production seeks to optimize its unit costs of manufacturing by long production runs without regard for the build-up of finished inventory and does not take notice of the impact it will have on the need for warehousing space and the impact on working capital.
In stage 2 companies have recognized the need for at least a limited degree of integration between closest functions, like distribution and inventory management or purchasing and materials control. From stage 2 it is a natural next step to stage 3. This, however, requires the establishment and implementation of an end-to-end planning framework. Stage 4 represents true supply chain integration in that the concept of linkage and co-ordination that is achieved in stage 3 is now extended to suppliers and to customers. Again it should be pointed out that logistics management is concerned with a planning coordination and framework that seeks to create a single plan for the flow of product and information through business. The supply chain management builds upon this framework and seeks to achieve linkage and co-ordination between processes that take place between customers and suppliers and the organisation itself.
Christopher is not the only author, who pinpoints the evolution of integration. Most of the literature used in thesis has an emphasis on this subject. Bowersox et al refer to it as the logistics organisational development cycle. They describe the subject of prevailing paradigm that goes from a fragmented to functional aggregation and to process integration. But the evolution of integration follows the same stages that have been discussed above.
Harrison and van Hoek encourage different forms of collaboration, internal collaboration, function to function, and inter-company collaboration, a manual approach.
According to Mattsson 2002, every barrier between individuals, departments and organisations requires more time and lead times become longer. Therefore a natural way to have more effective business processes is to reorganise with a fusion of performance and responsibility for different activities and sub processes between different departments within the company so that the number of borders are reduced. To organise in a more effective way could also take place between companies.
2.4.6 Supply Chain Optimization
Poirier and his associates have for over ten years studied more than two hundred global businesses in an effort to understand optimal supply chain integration. The studies were conducted with medium to large corporations seeking to gain advantage in their markets. Poirier and his associates have also conducted research into how companies build optimized supply networks. It is now apparent that the supply chain is the main pathway of all businesses. The observations and experiences have led to the identification of a supply chain progress range, from beginning efforts to a position of global advantage.
In today’s business organisations have shaped networks for sourcing raw materials, manufacturing products or creating services, storing and distributing the goods, and finally delivering the products and services to customers and consumers. A common name for this effort is supply chain management and the focus is moving externally as well as internally. Early efforts concentrated on improving only the internal efficiency of an individual firm or of a single component in the supply network.
The road to a leading-edge position requires focus, dedication, creativity, and hard work. The figure below is an illustration of the four levels through which a firm progress to achieve advanced stages of supply chain management and to understand the rewards that result from a drive for optimisation. Based on the experience of many companies, there is no way to avoid moving through these levels of development. A firm in the first level that wishes to be at the fourth level must develop a strategy for rapid movement through the in-between levels.
Figure 2.10. Levels of Supply Chain Optimization
Internal External
Sourcing and
Logistics
I Internal
Excellence
II Network
Construction
III Industry
Leadership IV
Driver VP sourcing (under pressure) CIO/supply chain leader Business unit leaders Management team
Benefits Leveraged savings Prioritized
improvements across network Best partner performance Network advantage, profitable revenue
Focus Inventory, logistics, freight, order fulfillment Process redesign, system improvement Forecasting, planning, customer
service,
interenterprise Consumer, network
Tools Teaming, functional excellence Benchmarks, best practice,
activity-based costing Metrics, database, mining,
electronic
commerce Intranet, internet, virtual information systems
Action Area Midlevel organization Expanded levels Total organization Full enterprise
Guidance Cost data, success funding Process mapping Advanced cost models,
differentiating processes Demand-supply linkage
Model None Supply chainintraenterprise Interenterprise Global market
Alliances Supplier consolidation Best partner Formal alliances Joint venture
Training Team Leadership Partnering Network processing
Source: Poirier, C., 1999.
The levels labelled Internal occur within the organisation and represent the position of most business organisations that seeks for improvements in their supply chains. Eighty percent of the companies studied by Poirier are somewhere in the Internal stage of their supply chain’s progress. The last two levels that are labelled External occur when the business joins forces with external firms to seek network savings. Few organisations have reached these latter levels. When analysing what stage FNS is positioned in, when considering the supply chain optimisation according to Poirier, Hogström and Grigorjev believe that FNS is positioned on level one because FNS focuses more on inventory, logistics, transport and order fulfilment.
2.4.6.1 Level One
In this section, the key elements of supply chain management evolution will be described.
Driver: The driver or supporter, who promotes the necessary change process in level one, could be a senior manager or department director who wants or is selected to organisation a change process. The emphasis generally begins with encouragement or a pronouncement from a CEO but emphasis rapidly moves to the vice presidential (VP) level or lower. The purpose could be to achieve a substantial gain in cost control, to organise an intensive improvement effort, or to reengineer a process that has risen dramatically in cost.
Experience indicates that responsibility may start with a variety of functional senior executives, but it soon ends with a senior procurement manager, such as the vice president of purchasing or sourcing. This is not always the case, but it illustrates the typical process in level one. Often a large percentage of costs are controlled by activities in this sector. The natural step is to put intense emphasis on cutting the costs of purchased goods and services, and this involves all aspect of operations. Experience suggests that a company should be careful of the consequences of this approach. As participants examined and changed their supply base, processes, systems and practises to support current requirements and objectives, they also discovered changes that might not improve their positions in the marketplace. Firms become very skillful at cutting costs through the leveraging of their volume and buying positions with suppliers. Many firms also paid a price in reduced quality and control. If a supplying firm accepts costs transfers from a manufacturer, there is also a transfer of profits: the buyer gains and the supplier loses. In this case the supplier only has two choices: to get back the lost profits through internal efficiencies or to pass back a comparable amount of costs to the buyer. A superior technique that gives the process greater value is when organisations work with suppliers by removing costs from the systems of supply and manufacture so both parties gain an advantage and share in the additional profits generated.
The lesson learned from efforts in level one showed the way for achieving true sourcing savings. The emphasis must be on using mutual resources for mutual advantage, rather than accepting cost pushback from one company to another.
Benefits: An early benefit of supply chain improvement efforts included project work by teams that reduced purchasing costs, inventories, logistics costs, and freight costs. As these teams were sent in search of quick opportunities, benefits were quickly identified and used to verify the importance of the effort.
Experience has shown that some savings in level one are fictitious. If a cost is simply pushed back to a cooperative supplier, the inventory carrying cost has been temporarily transferred within the supply chain network. Real savings begin when the network completely eliminates the need for the inventory by simplifying the process or eliminating steps that require extra inventory. In these cases, the carrying cost is eliminated on the inventory which is no longer required to sustain delivery performance.
Focus: As the focus is placed on specific supply chain projects such as inventory, logistics, freight, and order fulfilment, additional care must be taken to validate the assumed results. These areas were selected following purchasing because they represented large sectors of cost and were generally not being performed to leadingedge standards. Teams that went looking for opportunities to cut costs found some of the early savings mentioned. The teams’ focus led to two approaches: redesign or reengineer the process to become more efficient or find an external firm to which the process could be entrusted in order for the firm to concentrate on its core business. Order fulfilment turned out to be a challenge because most of the problems in this area were internal to the organisation. Absence of discipline was the source of most problems. The problem began with order entry and continued as the orders were processed and sent to planning, manufacturing, and delivery. Manual overrides were constantly necessary because of poor entry, omitted data, improper codes, incorrect pricing, and other mistakes. When companies found solutions to this problem they often rushed to eliminate people in this process. As errors were eliminated, processes were simplified, and automated systems were created and implemented and this often resulted in labours savings.
Tools: The tools applied in the first level of supply chain management generally centre on teaming techniques. Most organisations cannot overcome the strong temptation to begin internally and focus on favourite departments or processes. The teams map the current work activities or process steps to get a rough picture, process flow diagrams, use scientific methods of decision making, and other tools to energize the group. Encouragement and support from senior management are crucial in these early stages because creative innovations may lead to significant improvements in old processes.
Action Area: The action area occurs in the midsection of the organisation as functional managers and directors bear the burden of the responsibility for implementing the new processes. Purchasing managers know the intensity with which cost control is followed in these initial efforts. As other departments will be redesigned, the number of involved managers increases. In the beginning, team members tend to come from white-collar workers and later on blue-collar workers join the team, bringing their close knowledge of how work flows actually happen.
Guidance: Guidance comes from whatever cost or financial data can be accessed. Often a company relies on the available internal metrics used to measure the performance of a function or department. Early results show that information is often approximate at first, but become more accurate as the savings are quantified, challenged, recalculated to provide accurate results and promote funding for further efforts. Often other and more useful financial data is to be found in the effort to support the hypotheses. Areas that would not normally come under the attention of purchasing but still involve significant cost are investigated.
Model: No formal model is customarily used in the first level. The teams create their own methodology, and follow generally agreed teaming techniques. A simple flowchart or block diagram might be used to stimulate the brainstorming of ideas. Such diagrams show the transfer of products and services along the supply chain and focus discussions on problems and opportunities. These brainstorming sessions are used to analyse these flow charts and to consider opportunities for improvement. On the basis of these sessions, a list of prioritised opportunities is drawn up so that the best potential initiatives can be selected and implementation teams formed.
Alliances: With an increased level of cross-functional cooperation, the teams find that outside help and fresh advice can be very beneficial. Some supplier consolidations occur as the supply base is reduced and this is often the start of long-term alliances with some of the surviving suppliers. The real cross-company participation is held off until level two.
Training: The training effort is focused on developing capabilities in team formation, problem identification, root-cause analysis, and the other elements of good teaming work in the early stages. Teams are sent out in a perpetual search for improvement opportunities. The teams enlarge their scope as success is achieved and begin to rely on outside advice as they search for higher levels of savings.
2.4.6.2 Uneven Gains
Preliminarily results from supply chain improvement initiatives have been mixed. Most firms have identified and benefited from fast gains and increased profits. Supply costs have been reduced to some degree through concerted improvements in the purchasing function. Inventories have been either cut or moved upstream in the supply chain and warehousing and transportation costs have usually been reduced. A few lessons stand out in early results. No firms as an individual can shrink its way to greatness. It must cooperate with valued suppliers and distributors. It must focus on specific markets, customers, and consumers. It must operate in an environment that is completely transparent to all element in the supply chain so that each player can see what and when moves the customers, and to identify sources of potential savings. The barriers that hold back the sharing of vital information, barriers that drive costs up and service down, must be uncovered and overcome as a new culture is built.
A missing factor plagued the less successful organisations. The failure was in two key areas: a lack of trust and sincere effort among necessary participants in the chain and a narrow-minded view focused only on internal gains. Progress in developing trust was not made or sustained because the firms that were engaged in supply chain redesign did not seize the need for sharing the savings with the organisations that helped improve the system. These firms also failed to develop cross-organisational trust, which is now recognised as a crucial success factor. In these early efforts, some firms sought an advantage at the expense of suppliers by leveraging their position with those firms and pocketing all the savings. It became a zero-sum game, and that is a prescription for failure.
Leading companies realise that internal operational excellence must be balanced with external supply network efficiency, the ultimate objective of which is to please the final consumer.
Early efforts at supply chain optimisation proved that the enemy is typically within the organisation. Supply chain improvement efforts have to cross division, department, function, location, and territory boundaries. The people within those boundaries will initially support any effort designed to significantly improve processes, reduce operating costs, increase revenues, and bring the firm into the modern era. Much of this support is cosmetic and must be watched closely. There is far greater concern in the beginning of a supply chain improvement effort about maintaining the status quo than in making necessary changes. A simple but hardlearned lesson is good to apply in this case: begin with a small project to prove the concepts and complications, and develop answers before proceeding to larger and more complex opportunities.
2.4.6.3 Transition to Level II
Once a business organisation has discovered the early, primarily internal benefits available from improvements within a supply chain, it can move to the next phase. This transition to a higher level of supply chain management is difficult for some organisations. The tendency is to get stuck in the early and relatively easy stages of the process. Most firms continue to find other projects that will enhance internal supply chain performance but never really move on to higher-order efforts and benefits. To make further progress requires redesigning the total supply chain system and eventually the total supply chain network. Standing in the way are several pitfalls. The organisations interested in reaching advanced levels must identify these obstacles and overcome them. Some examples are as follows:
? To drive the organisation to higher levels of costs reduction, productivity, quality, and service, energy must come from one or more of three sources: executive motivation, a system that tracks progress and rewards the people who made it happen, and a vision that embraces ongoing change in the future.
? Most firms stuck in Level I are characterized foremost by refusing to share savings from the improvement effort. Sharing the real savings is a mark of the organisation of evolution to Level II and beyond.
? A Level I firm will not allocate, hire, or contract with the people that are necessary to move to the next level. This means that insufficient resources will delay the progress. It is far easier for these firms to ignore the advanced opportunities claiming that these resources are not worth the extra spend-
ing or stalling efforts until internal resources can be developed and applied.
? A specific characteristic of Level I efforts is progress in virtually all areas of supply chain management, except one – forecast accuracy. Getting better information into a supply chain system regarding how much actual demand will exist in a specific time frame is a common challenge. With poor demand input, the planning process relies on educated guessing as best. The resulting system only works because of heroic service and not because of organised reactions. Level I firms are always responding to unexpected changes.
? An argument always raised in Level I efforts revolves around what should happen first, the installation of new information systems or the redesign of processes for higher efficiency. The greater gains occur when the redesign of the process is logically tested and aligned properly with the IT application. For Level I firms, the tendency is to develop process improvements and technology enhancements without any real integration. Advancing to the next level requires the functional groups and the IT department to codesign the new processes with what will be the best IT format.
? The single greatest obstacle to advanced supply chain improvement is a lack of trust among the parties who will benefit most from cooperation in pursuing joint goals. Supply chain improvements by its very nature requires total co-operation, and departments have to work together. Key suppliers have to play a role in design and application. Distributors have to play another role in handling small lots and specialised market sectors. Customers have to help determine what should be coming through the chain. In this situation interaction is crucial, but this interaction seldom happens in Level I. Savings do occur and will benefit the own organisation that trust will remain elusive.