BUSINESS LOGISTICS

Business logistics refers to a group of related activities all involved in the movement and storage of products and information—from the sources of raw materials through to final consumers and beyond to recycling and disposal. Business logistics is a relatively new term and concept in modern business vocabulary; its origins can be traced back to World War II when the ability to mobilize personnel and material was critical to the outcome of the war. The first university level courses and textbooks dealing with business logistics appeared in the United States in the 1960s.

The relatively recent development of business logistics has led, as it has evolved, to the use of a variety of terms to refer to it. In the 1960s and 1970s the terms physical distribution, distribution, materials management, and physical supply were common. Physical distribution and distribution refer to the outbound flow of goods from the end of the production process to the consumer; physical supply and materials management refer to the inbound flow of material to the production process. As the importance of coordinating the entire flow of material from the raw materials to the end consumer became recognized, the term business logistics became widely used to reflect the broadening of the concept. Today, the term supply chain management is coming into use to reflect the importance of forming alliances and partnerships to streamline the flow of materials. Business logistics remains the dominant, all-encompassing term for this important concept at this time.

The most widely used definition of business logistics is that of the Council of Logistics Management (CLM) of Oak Brook, Illinois, the largest and best known of the professional logistics organizations. The CLM definition states, "Logistics is the process of planning, implementing and controlling the efficient, effective flow and storage of raw materials, in-process inventory, finished goods, services, and related information from point of origin to point of consumption (including inbound, outbound, internal, and external movements) for the purpose of conforming to customer requirements."

For many people, what is often referred to as the "seven rights" provides a good working definition of logistics. The seven rights state that the logistician's job is to ensure the availability of the right product at the right time in the right quantity in the right condition at the right place for the right customer at the right cost.

Although these definitions refer primarily to managing the flow of goods, business logistics is also important in service organizations. It is important to recognize that all firms produce both goods and services, some more of one than the other, that all firms purchase supplies; and that all must meet or exceed customer expectations. In service organizations the logistician's job is to ensure the provision of all required inputs, including materials and information, at the point of service delivery.

To the organization, business logistics is important in several ways. First, business logistics provides an opportunity for the firm to create a sustainable competitive advantage for itself by designing a system which fulfills customers' needs better than the competition. For example, the firm could offer faster, more accurate, and more consistent order filling and delivery than competitors are capable of providing. Secondly, due to its complexity, a superior logistics system is a proprietary asset that cannot be easily duplicated. Many firms have begun to view business logistics as an effective competitive weapon.

HISTORY AND BACKGROUND

The activities that make up business logistics, such as transportation and storage, are as old as trade itself. The concept of grouping them together and managing them as a system, however, is quite new.

Traditionally, the responsibility for logistical activities has been scattered throughout the organization. For example, transportation might be under manufacturing, with finished goods inventory and warehousing under marketing and sales. Where management of the logistics system is uncoordinated, diseconomies will be found. For example, manufacturing may choose to reduce transportation and manufacturing costs by producing and shipping in very large quantities—and in so doing greatly increase the costs of storage and the investment in inventory well beyond the amount saved in transportation costs. With proper coordination, transportation, manufacturing, storage, and inventory, investment costs could be balanced so that the firm's total cost would be minimized. The initial development of business logistics began in the 1950s with an understanding of the potential for cost savings if the management of the logistical activities was coordinated.

There were a number of factors present in the 1950s that encouraged attempts to coordinate the management of logistical functions. In general, these attempts focused on cost savings and on the physical distribution or outbound part of the system.

An important factor present in many organizations involved managers with military logistics experience from World War II. Not only did they have an understanding of the interrelationships found in logistics systems, but some of them had also used management science techniques developed during the war—such as linear programming and simulation, which are well suited to analyzing logistics problems.

Another factor that proved to be important in focusing management attention on logistics was the economic recession of 1958. Cost cutting was brought on by the recession, and many firms targeted logistics because it was believed to have more potential than manufacturing and marketing. Manufacturing had been studied by industrial engineers for many years, and it was believed that most of the excess costs had already been squeezed out. Marketing, although costly, was not understood well enough to intelligently cut costs. For example, most firms were probably spending more than was optimal on advertising, but the relationship between sales and advertising was not known well enough to tell which advertising costs to cut. In addition, marketing costs are often difficult to quantify, whereas logistics costs can be quantified. Tangible things that are moved and stored can be tracked.

GROWTH OF RETAILING AND PRODUCT
PROLIFERATION

Two other developments in the business environment that began during this period and persist to the present are the proliferation of products and the shift of power to retailers from large manufacturers of national brands. The proliferation of new products and variations on existing products is the outcome of the application of the marketing concept and market segmentation. Marketers, attempting to satisfy their customers' increasing interest in fashion and their changing lifestyles, have offered more and more products to smaller and smaller segments of the market. Examples abound on retailer shelves. Consider such products as large appliances originally available only in white, or plastic trash bags, cereals, frozen prepared foods, athletic shoes, office furniture, cosmetics, and so on. Not only are more and more products available, but the life cycles of the products are shortening. To remain competitive manufacturers must offer a continuous stream of new products.

Product proliferation and shorter product life cycles force logisticians to deal with growing complexity. Each time a new product or product variation is offered, it increases the number of products to be manufactured, stored, transported, and generally kept track of. At the retail level the problem is compounded. A manufacturer may add a new color of a product, thereby increasing its product line by one; but if all four of the manufacturer's competitors also add the new color, the retailer will be faced with five new products.

As retailers such as Wal-Mart and Kmart continue to grow in size and as their knowledge of the market becomes more and more sophisticated, their power relative to manufacturers also grows. As retailers expand to serve national and international markets, they control access to larger and larger segments of the market. In addition, with the use of point-of-sale computerized information systems, retailers have much better and more timely information about customers than manufacturers.

Initially retailers used their newfound clout to push inventory back onto manufacturers. They reduced the storage space in stores and required smaller and more frequent deliveries to stores, thus increasing both transportation and inventory costs for manufacturers. More recently retailers such as Wal-Mart have used their size and information systems to forge partnerships with manufacturers and to design streamlined logistics systems that are more economical and result in fewer empty spaces on retail shelves. For example, sales information may be fed directly from the point-of-sale to the factory where production schedules are developed based on actual demand; and the product is then shipped directly to the retailer, bypassing several previously used storage facilities.

All of these factors caused many organizations to focus on their logistics systems in a way that was different than any time in the past. The recession, combined with more products to manufacture, move, and store as well as retailers forcing inventory back on them, caused manufacturers to focus on the large potential cost savings available from managing logistics as a system.

EVOLUTION OF COMPUTER SYSTEMS

Another factor whose importance to the development of business logistics cannot be underestimated is the evolution of computers and computer systems. To realize its full potential, business logistics management requires the timely processing and analysis of tremendous amounts of data. It is not uncommon for a firm to have thousands of customers ordering thousands of products—resulting in tens of thousands of transactions and shipments, hundreds of suppliers shipping thousands of parts and components, and multiple factory and warehouse locations—each with inventories to be tracked. All of this occurs simultaneously across several countries and continents.

Needless to say manual analysis and day-to-day control of all these facets is not possible. It is probably not an overstatement to say that the computer has allowed the business logistics concept to be implemented. The computer is essential to process the thousands of transactions and record changes that occur daily. Computers are needed to analyze the logistics system. They're needed to make plans concerning such things as optimal warehouse location, the amount of inventory to have on hand at the various warehouses throughout the system, the efficient scheduling and routing of trucks, the factories' production schedules, and many other crucial decisions.

BUSINESS LOGISTICS COMBINED
PHYSICAL DISTRIBUTION AND
MATERIALS MANAGEMENT

During the 1950s and 1960s logisticians concentrated on reducing costs primarily in the physical distribution or outbound side of the system. In the 1970s attention shifted to the materials management or inbound side of the logistics system and to improving customer service along with reducing costs. The shift in focus to materials management was largely the result of the OPEC oil embargo, which severely limited supplies of petroleum and related products such as plastics. Many firms began to place emphasis on using the logistics system to improve customer service as the pace of competition quickened in the United States, especially from firms located overseas. The net result was that many firms began to look for ways to integrate materials management and physical distribution and thus to adopt the concept of business logistics. In addition, many firms began to view business logistics as a way to strengthen their relations with customers through improved customer service.

The 1970s were also a time of relatively high inflation and interest rates. The high interest rates prompted many firms to reconsider their investments in inventories and to look for ways to reduce them.

The 1980s began with the federal deregulation of transportation in the United States. The changes in transportation regulation resulted in a much more competitive and flexible transportation system. Freight rates fell and transportation companies were allowed to tailor their service to the needs of individual customers. Many companies were also able to reduce inventory levels by using fast, responsive transportation service to deliver to customers from centrally located inventories, rather than having products stored close to customers.

The 1980s also saw the full development of truly global companies. These are companies that source parts and components in different countries for assembly in another country into products destined for markets in several others. The scope and complexity of the logistics systems of these firms far exceed those of a purely domestic company. The success or failure of such firms is even more dependent on an effective logistics system.

A third development of the 1980s, which has had profound effects upon the concept of business logistics, was the introduction of just-in-time (JIT) production from Japan to the rest of the world. The idea of producing only what is required at the time it is required has revolutionized repetitive manufacturing. Small quantities are delivered frequently on very stringent schedules in JIT manufacturing. Such systems are very dependent upon the logistics system to perform nearly flawlessly—not only in terms of meeting schedules but also in terms of doing so economically. It is necessary to combine several small shipments together in order to maintain transportation economies. Such systems require a great deal of planning and coordination across organizations to perform properly.

NEW DEVELOPMENTS IN
COMMUNICATIONS TECHNOLOGY IN
THE 1990S

During the 1990s the major factors affecting logistics are the developments in communications technology, such as electronic data interchange (EDI) and global positioning systems, the growth of third-party logistics organizations and strategic alliances and partnerships, and the tendency to view logistics as an important component in the firm's overall strategy.

Electronic data interchange (EDI), which is simply the passage of business information electronically between organizations, such as computer-to-computer ordering and invoicing, allows for the rapid transfer of information between the various organizations involved in the supply chain. For example, a manufacturer's computer calls a supplier's computer to place an order to be delivered at a specific time. The supplier's computer places the order in the production schedule and arranges for transportation by placing an order with a trucking company. The supplier's computer also keeps the manufacturer informed of the status of the order and when the trucking company picked it up. The trucking company's computer advises the manufacturer of the shipment's expected time of arrival at the manufacturer's factory. If something goes wrong, such as the truck being delayed by an accident, all parties will be informed and can formulate a contingency plan.

Global positioning systems (GPS) make possible the precise tracking and monitoring of transportation equipment. A truck outfitted with a transponder can transmit a signal to a satellite, which then signals a home base with the truck's location. In this way the truck and its contents can be followed. The trucking company's computer would keep track of the progress of the trip and advise the manufacturer, or the manufacturer could track its progress by asking the trucking company's computer for updates. Some systems now have the capability to monitor such things as the truck's engine temperature, oil pressure, and brake systems. The type of capability made possible with technology such as EDI and GPS make JIT systems possible and allow firms to operate with leaner inventories across many countries and continents.

Third-party or contracts logistics companies began to grow very rapidly in the 1990s. These companies allow a firm to spin off all or part of the management and operation of its logistics system to an outside expert, thus freeing up assets and management attention for the firm's core business. Modern communications technology such as EDI allows firms to spin off important logistics activities to third parties and still closely monitor and control the logistics system. The relationship of the manufacturer and the third-party logistics firm is often a long-term strategic alliance or partnership, where the manufacturer entrusts the operation of an important part of its business to the third party and the third party makes a major commitment of its own assets to the manufacturer. The contract logistics market was estimated at $34.2 billion in 1997, with about 70 percent of all Fortune 500 companies using third-party logistics firms.

Another development has been the recognition by a growing number of organizations of the strategic benefits of a well-run logistics system that is structured to enhance the overall strategy of the firm. Wal-Mart is a good example of this. Wal-Mart's basic strategy is to be the low-cost/low-priced retailer of general merchandise. Like others who have this same basic strategy, Wal-Mart manages its stores efficiently and buys in volume at low prices. Where it excels and beats the competition, however, is in the management of its logistics system. Through the use of a very sophisticated communication system and strategically located distribution centers, Wal-Mart is able to supply its stores with proportionately fewer assets tied up in inventory and less money spent on transportation than its competitors. Wal-Mart's logistics system is estimated to give it a 2 to 3 percent overall cost advantage over rival Kmart.

LOGISTICAL ACTIVITIES

Logistical activities are the basic functions that have to be performed in any logistics system. It is important to recognize that they are the components of a true system, in that they are all interrelated. Very often a change in one will create a ripple effect of change throughout the entire system.

The basic logistics system can be described very simply. The process begins with a customer placing an order with the organization. A product is then either produced or shipped from an inventory to the customer. As more products are sold, more raw materials must be acquired from suppliers and more products produced to fill demand or replenish inventories. The way that the parts of this system are configured will determine how and when the customer receives the order. Thus, the output of the logistics system is customer service, and the job of the logistician is to design a system that delivers a desired level of customer service at the lowest total cost. Cost-cutting, while important, must be balanced with the need to provide optimum levels of customer service and satisfaction.

Customer service can be defined and measured in many ways, and in most firms multiple measures will be used. For example, customer service could be defined as the percentage of times a customer order can be filled from inventory (product availability), or the length of time it takes to get the ordered product to the customer (order-cycle time), or the percentage of orders for which the correct product is sent to the correct destination, or the percentage of orders the customer receives undamaged. The consistency or variability of the length of time it takes to get orders to customers has been found to be very important to customers, more important than the average length of time to fill an order. Most customers, if forced to choose, would take consistency over speed. In other words, an average order cycle of 10 days with no variability would be preferable to one which averages 4 days but could take up to 14.

The starting point for the design of a logistics system is the determination of customer service levels that will give the firm a strategic advantage over competitors. The logistician must learn which elements are important to customers, how well competitors perform them, and how well the logistician's organization is perceived to perform them. The logistics system must then be designed to deliver the required level of service at the least possible cost. Determining customer service levels is an ongoing, never-ending task, because customer needs are constantly changing and evolving—presenting challenges and opportunities to the firm and its competitors alike.

MODES OF TRANSPORTATION

Transportation is a very important element in most logistics systems. It is often the most expensive element. Transportation is composed of five modes (air, truck, rail, water, and pipeline) and the individual companies or carriers within each mode, such as Union Pacific Railroad or Roadway Express. The logisticians' job is to select the modes and carriers that will deliver the desired level of service at the lowest cost.

Each mode is different in terms of its speed, reliability, cost, route flexibility, and the products it can carry efficiently and effectively. For example, air transport is often the fastest, but it is also the most expensive and is not usually practical for transporting large bulky commodities. Also, for short distances a direct truck delivery is usually faster than air. Truck deliveries account for at least a portion of most freight movements because they have the greatest route flexibility, are relatively fast, have moderate cost, and can carry a wide range of products. Railroads are usually used to carry large quantities over long distances (over 500 miles). Pipeline and water are relatively slow and inexpensive. Pipeline has the least route and product flexibility, and water is susceptible to weather problems such as droughts, flooding, and storms.

Intermodal transportation is when two or more modes are combined to take advantage of the strengths of each. For example, the most popular form of intermodal transportation is the combination of truck-route flexibility with the railroads' inexpensive long-haul capabilities. In one version of truck/rail intermodal transportation called piggyback, a truck trailer is placed on a railroad flatcar. The pickup and delivery is performed by truck, while the long-haul terminal-to-terminal transportation is performed by rail, thereby capitalizing on the strengths of each mode.

Individual transportation companies or carriers also have varying characteristics. For example, the prices or rates they charge, the condition and age of their equipment, the points they serve, the length of time it takes them to get a shipment to a particular place, and the likelihood of the shipment being damaged may all vary from one carrier to another. In general, for both modes and carriers, the faster and more reliable they are, the more expensive they will be.

The logistics manager also has a choice as to whether the carrier to be used will be a common carrier or a contract carrier, or if the organization should buy its own trucks and set up its own do-it-yourself transportation company—called a private carrier. A common carrier is a transportation company that offers its services to the general public on a for-hire, as-needed basis. A contract carrier is a carrier with which the organization establishes a longer contractual arrangement. Often the contract carrier will dedicate equipment to its customer and tailor its service to that customer, whereas a common carrier will offer mostly the same service to everyone on a first-come, first-served basis. Many organizations set up their own private transportation operation, especially if they have unique service requirements that cannot be met by common carriers. The disadvantage of having a private carriage operation is the investment in equipment, facilities, and people to operate and manage it. Contract carriage is often a good compromise.

DEALING WITH INVENTORIES

The logistician has many choices to make in designing the transportation component of the system. Inventory is a very important part of a system and is found in many places throughout the logistics system. On the inbound side inventories of raw materials, parts, and components are kept in anticipation of their use in manufacturing. Within manufacturing, work-in-process inventory is found between the various stages of production and in production. Finished goods inventories may be kept in anticipation of demand by customers and may be found at plants or in warehouses in the field close to customers.

There are several very good reasons for having inventory in the logistics system. One of the most obvious is for customer service. Products are produced in advance of customer orders so customers do not have to wait for them to be manufactured. Customers are served directly from stock. Inventories may be held because suppliers offer cheaper prices if purchases are in large volumes. In addition, the cost of transporting them is lower if they are moved in large volumes. Inventories may also be held to achieve manufacturing economies. By producing in large lots that exceed immediate levels of demand, the costs of manufacturing may be reduced. Seasonality of products or seasonality of customer demand may also lead to inventories in the system. For example, tomatoes may be harvested in August and canned and stored to fill demand in the winter months. Seasonal products such as lawn furniture may be manufactured year-round but only sold in the spring and summer. During the fall and winter an inventory is built to satisfy demand in the warmer months. Finally, some products may require aging or ripening, such as meat and bananas.

Although there are very good reasons for carrying inventory, there are always costs associated with it. The largest cost of carrying inventory is the cost of capital tied up in the inventory. In other words, if the firm did not have its money invested in inventory, it would be able to use that money elsewhere to increase its productive capacity, or at the very least it could put it in an interest-bearing savings account. The capital cost of carrying inventory is an opportunity cost. If the money had not been tied up in inventory, it could have been used to produce income. The income not produced is the opportunity cost. Other costs of carrying inventory include the danger that the product may become obsolete before it is ever sold or that it will be damaged or stolen while in storage. In addition, taxes may have to be paid on the value of the inventory, insurance may have to be bought to protect against loss or damage, and the space occupied by the inventory may have to be paid for. Holding inventory can be a rather expensive undertaking.

While the costs of carrying inventory may be a deterrent to keeping inventory, there are several other reasons for not carrying it that may be even more important than the cost. Inventory can be used to cover up problems rather than find solutions. For example, an inventory of parts may be used to cover up quality problems with a supplier. When a defective part is found, it is just put aside and a replacement is found in the inventory rather than going to the supplier and correcting the cause of the defective part. Another example could be late, inconsistent deliveries from a supplier. An inventory of parts kept on hand to be used when deliveries are late rather than correcting the cause of the problem is obviously inefficient and wasteful.

Another problem caused by carrying too much inventory is that it reduces the firm's flexibility to meet changing customer preferences. A company with large stocks of current products and parts on hand must use up the inventory in the system before a new product can be introduced. In fast-changing markets competitors with lean inventories are able to adjust more quickly to changing customer needs.

OTHER LOGISTICS CONCERNS

Logisticians must continuously search for ways to acquire materials and operate factories efficiently while satisfying customers and carrying as little inventory as possible. Warehouses and distribution centers (DC) are where much of the inventory is kept. They are used to improve customer service by moving goods closer to the market and to reduce transportation costs by allowing goods to be shipped in large, economical loads to the DC, rather than from the plant in small, expensive shipments. Customers can be served more quickly from stock located in a nearby DC than from a remote stocking location.

Logisticians can choose between renting or leasing space in a public warehouse or building and operating the company's own private warehouse. A private warehouse or DC may be attractive if the firm's products require special handling, care or equipment, or if the facility can be used intensively. Public warehouses are attractive to firms that have seasonal sales patterns that would prevent them from fully utilizing the facility, or for firms that value the flexibility of being able to withdraw on short notice from a particular market. The logistician must decide how many warehouses and DCs to use, whether they should be private or public, and where they should be located to provide the desired level of service at the lowest possible cost.

The materials handling system is the equipment within the warehouse that consists of such things as cranes, forklift trucks, racks, and shelving which is used to move and store the inventory. The materials handling system is designed to handle a certain volume of goods of various dimensions and weights, and the warehouse is designed to enclose the materials handling system.

Logisticians are also concerned with protective packaging of the firm's products. The package should be strong enough to protect the product from all of the threats it is likely to encounter throughout the logistics system, yet be economical. The package will have a significant effect on the design of the materials handling system. For example, the dimensions and weight of the package and its stackability will influence the type of materials handling equipment that is suitable.

The materials management side of the logistics system is designed to support the production schedule that determines where the firm's products will be produced, the quantities to be produced, and the timing of that production. The acquisition and procurement of raw materials, parts, and supplies are designed to feed the production schedule. The location of the source of inbound materials and their destinations, the quantities to be shipped and the timing of the deliveries all have serious implications for transportation, inventory levels, production schedules, and ultimately customer service. For example, companies using just-in-time production want small quantities of inbound materials shipped frequently to arrive on rigid time schedules, preferably from nearby suppliers.

In addition to the major logistical functions discussed above, many logistics managers are involved with related issues such as demand forecasting, salvage and scrap disposal, return goods handling, parts and service support, and plant location.

THE FUTURE OF LOGISTICS

Looking ahead to a new millennium, business logistics and supply chain managers will be faced with an accelerating demand to deliver better products faster and cheaper on a global basis. There will be opportunities as well as challenges. Logistics managers will be called on to maintain supply and keep up with deliveries in an electronically linked international business community. And they will be performing in a rapidly changing business environment as the pace of business change accelerates over the next decade. Meeting the demands for faster cycle times will require close cooperation throughout each business's supply chain, as companies come to rely on more partners to achieve their logistics goals.

Globalization of business will be enhanced by regional trade agreements and the reduction of trade barriers as well as through international electronic networks such as the Internet. Such globalization will result in new consumer demographics as densely populated nations such as China and India become part of the global marketplace. As companies are faced with consumer demands from around the globe, speed and simplicity of delivery become ever more important.

New technologies will play an increasingly important role in business logistics, if they aren't already. New software tools will provide managers with better ways to analyze the performance of logistics networks. Internet applications will open up internal information to all participants in the supply chain. The demand for speed will result in companies taking inventory out of their systems, with technology providing much of the ability to meet the demands for speed and simplicity. The ultimate, though perhaps unattainable, goal of logistics will be zero inventory and immediate availability.

Outsourcing of logistics will likely increase as the growth of third-party logistics firms continues. For those companies that handle their own logistics, the challenge for managers will be to communicate to their company's senior management the advantages that logistics can provide.