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10. INBOUND LOGISTICS

Inbound side of logistics includes procurement or purchasing and the related materials management activities. It is important to note that the inbound and outbound logistics systems share common activities or process, since both involve decisions related to transportation, warehousing, materials handling, inventory management and control, and packaging, as well as some other activities. In this lecture, we will look at the materials management and procurement activities of an inbound logistics system and to discuss more fully those activities that are especially important on the inbound side, such as procurement and inventory management.

10.1. INBOUND LOGISTICS ALONG THE SUPPLY CHAIN

The differences that exist among the inbound systems of different companies have important implications for the design and management of logistics supply chains. A supply chain is made up of a series of individual companies. MINING FIRM The start of a supply chain could very well be a mining operation involving the extraction of coal or some ore commodity. In this case, the inbound logistics system is essentially a part of the extractive or production process. Therefore, inbound logistics would be very difficult to separate out for analysis from the mining operation except to the extent that the extractive company purchases supplies for use in the mining process that must be stored and transported prior to the extractive process. Extractive companies would be most concerned about their outbound system, which would be involved in delivering appropriate quantities of their commodity at the right time and place to the next firm in the supply chain. The inbound system of the extractive company would probably not receive as much separate attention as would the inbound system at the next firm in the supply chain. FIGURE 1: A FOOD SYSTEM SUPPLY CHAIN Coal mine Steel mill Container plant Food processor Store Consumers

STEEL FIRM As we move along this hypothetical supply chain, the next company could be a steel manufacturer. The coal would be an important raw material for this firm, and it would probably transform the coal to coking coal in its coke plant. However, it could also buy coking coal from an intermediary company that buys coal and specializes in producing coking coal. (Obviously, if the latter were true, we would have another company in our supply chain.) In addition to the coking coal, the steel company would utilize several raw materials from a variety of vendor sources to produce the steel. These materials would have to be procured in appropriate quantities, transported, stored, and their arrivals coordinated via the production planning process in advance of the manufacturing process for producing the steel. Therefore, the steel company would be very much aware of its inbound logistics system and the need to coordinate inbound logistics activities.

2 CONTRAST BETWEEN THE INBOUND AND OUTBOUND SYSTEMS On the inbound side, the nature of the raw materials, coking coal, iron ore, and so on, are such that they can be shipped in bulk in railcars and barges and stored outside in piles. On the other hand, the, the finished steel would need more sophisticated transportation, warehouse, inventory control, materials handling, and so on. Therefore, the inbound and outbound logistics systems could have some unique network design requirements. CONTAINER FIRM Once the steel is produced, it would be ready to move along the supply chain to the next firm, which could be another manufacturer such as an auto or a container manufacturer. Assuming that the supply chain we are concerned about will ultimately result in food products in a store, the next point would be the container company that produces cans of various sizes for the food processors. It is important to note that the steel company would usually be a part of several supply chains. That is, the steel company may also be selling to auto manufacturers, office supply producers, and other types of manufacturers. FOOD FIRM The next step in our supply chain would be the food manufacturing plant, where processed food would be added to the cans of various sizes. Food processing companies frequently add labels later, since the different company labels. By storing the cans and adding the labels when orders are received, the level of inventory can be reduced because of the reduction of uncertainty. That is, it is much easier to forecast the total demand for a certain size of canned peas than it is to forecast the demand for each companys labelled cans of peas, since individual market shares change. RETAIL STORE Once an order for the peas has been received from a retailer, the labels can be added and the peas shipped to the retailers warehouse or store. When the peas finally end up in the store for sale, we have reached the last point in our supply chain, although you could argue that the cycle is not complete until the can of peas end up in a consumers home. In fact, in todays environment, that can may be recycled after the peas are consumed and the materials may start back through part of the supply chain again a reverse logistics system. THINGS TO NOTE

COMPLEXITY: The difference in complexity that exists among companies For example, an automobile manufacturer typically has about 13,000 individual parts in the inbound system in order to assemble or manufacture an automobile. The inbound system for the steel plant mentioned previously is relatively simple compared to that of the auto manufacturer. The steel company has a limited number of raw materials that are shipped in bulk and are stored outside. Some aspects of inbound logistics systems for steel production are challenging, but not

3 nearly as challenging as the inbound system for automobile production.

10.2. MATERIALS MANAGEMENT

Effective supply chain management requires careful coordination of the inbound system of logistics, which is frequently referred to as materials management, and the outbound system, which is usually called physical distribution. The integration of the inbound and outbound system is extremely important to the efficient and effective management of the logistics supply chain. Information flow is often the key ingredient to the coordination of inbound and outbound. Since the information regarding product demand flows down the supply chain, the possibility exists that decisions related to the flow of materials will not be coordinated with the customer, especially with respect to inventory accumulation and/or lack of appropriate flow quickly in both directions for effective coordination. Materials management can be described as the planning and control of the flow of materials that are a part of the inbound logistics system. Materials management usually includes the following activities: procurement, warehousing, production planning, inbound transportation, receiving, materials quality control, inventory management and control, and scrap disposal.

PROCUREMENT

It can be defined as the process (completion of a series of activities) of obtaining goods and services for the firm consistent of user requirements. It links members in the supply chain and assures the quality of suppliers in that chain. The quality of the materials and services that are input affects finished product quality and hence customer satisfaction and revenue.
WAREHOUSING

The warehousing function concerns the physical holding of raw materials until a firm uses them.
PRODUNCTION PLANNING AND CONTROL

In a manufacturing environment, production planning and control involves coordinating product supply with product demand. The starting point of the production planning and control process is the demand for the finished product the company produces and sells. This demand is the processs independent variable, since the seller cannot control customer demand. The manufacturer must forecast, or estimate, customer demand.
TRAFFIC

The traffic function manages the inbound transportation of materials.

RECEIVING

The receiving process involves the actual physical receipt of the purchased material from the carrier. The receiving clerk, who must ensure that the goods a firm receives were those ordered and shipped, compares the materials indicated on the buyers purchase order and the vendors packing slip with the material the buyer has actually received. If discrepancies exist, the receiving department notifies the purchasing department, the materials users, and the accounts payable department.

QUALITY CONTROL

It is directly concerned with defining the products quality in terms of dimensions, design specifications, chemical or physical properties, reliability, ease of maintenance, ease of use, brand, market grade, and industry standard. SALVAGE AND SCRAP DISPOSAL The final activity in the materials management function involves disposing of salvage, scrap, excess, and obsolete materials. Although primarily concerned with buying, the materials management department has assumed this selling responsibility, since most marketing or sales department must concentrate on selling the firms finished products. Scrap and salvage material that is useful to others has a certain value, and the disposal of these items provides income for the firm. The recent recycling trend had provided a ready market for many scrap and salvage items. For example, companies are using used oils and other scrap items such as olive pits and corncobs as fuel sources. And, as recent years of double-digit inflation have sent new equipment prices beyond the ability of many potential buyers to pay, more companies are buying or salvaging used equipment.

10.3. THE SPECIAL CASE OF INVENTORY

In both STAT279 and STAT379 we have looked at various inventory models to run systems at minimum cost. In doing so we have formulated an inventory policy which consists of guidelines concerning what to purchase or manufacture, when to take action, and in what quantity. Another aspect of inventory policy concerns inventory management strategy. One approach is to manage inventory at each distribution centre independently. The other extreme considers inventory interdependence across distribution sites by managing inventory centrally. Centralised inventory management requires more coordination and communication. When demand or supply is uncertain, it is common for firms to keep safety stock, these being items held to protect against the impact of uncertainty on each facility. This safety stock is used only at the end of replenishment cycles when uncertainty has caused higher than expected demand or longer than expected performance-cycle times. The basic idea of safety stock is that a portion of average inventory should be devoted to cover short-range variation in demand and replenishment. If safety stock exists, average inventory is said to equal one half of the order quantity plus the safety stock. In many inventory models the concept of carrying cost is used in various formulas. While calculations involving carrying costs are straight-forward, determining the appropriate carrying cost percentage is quite difficult. Finding the true cost of maintaining inventory requires judgement, estimation of average inventory levels, assignment of inventory-related costs, and a degree of direct measurement. The accounts traditionally included in the cost of maintaining inventory are: Capital

5 Insurance Obsolescence Storage Taxes The final figure is expressed as an annual percentage value applied to average inventory. Once it has been determined, it should be held constant during logistical system analysis. EXAMPLE 1 Define what is meant by inventory carrying costs. What are some of its main components? In many companies, inventory is the first or second largest asset. Inventory is an investment similar to a piece of equipment. Significant costs are associated with holding inventory. The interest in reducing inventory levels along the supply chain is indicative of the importance of inventory as a cost of doing business. Companies can reduce their costs of doing business and improve their return on investment or assets in many cases by decreasing inventory levels. The investment in inventory can add value by reducing costs in other areas, such as manufacturing and transportation, or enhance sales through better customer service. Therefore, a balanced view is necessary when making inventory decisions, one that recognizes both the cost implications and potential benefits of maintaining inventory in the supply chain. Materials management (inbound logistics) plays a major role in driving inventory levels up or down in a supply chain. It is generally recognized that final customer demand should be the magnet that pulls inventory through the pipeline, but production planners, schedulers, and purchasing agents sometimes operate somewhat independently of the outbound logistics system. When a non-coordinated approach is taken, inventory levels can easily increase without improving customer service or lowering costs in another area. There are several approaches to inventory control that have special relevance to materials management: just-in-time (JIT) systems and materials requirement planning (MRP) systems. Also distribution resource planning (DRP) has a significant relationship to MPR. MATERIAL REQUIREMENTS PLANNING (MRP) This is an inventory and scheduling model for supplying materials and component parts where demand depends upon the demand for a specific end product. It is a tool used to plan for the manufacturing of products. It is a production and inventory control system that attempts to keep inventory at a minimum while ensuring that adequate materials are available for production. Usually when the demand for different items is dependent, the relationship between the items is known and constant. Thus, you should forecast the demand for the final products and compute the requirements for component parts. BENEFITS OF MRP

6 Increased customer service and satisfaction Reduced inventory costs Better inventory planning and scheduling Higher total sales Faster response to market changes and shifts Reduced inventory levels without reduced customer service

Although most MRP systems are computerised, the analysis is straightforward and similar from one computerised system to the next. A typical procedure will be discussed next week. THE JUST-IN-TIME (JIT) APPROACH This is an approach whereby inventory arrives just in time to be used in the manufacturing process. Based on the example of many Japanese companies (most notably Toyota), many American companies (Xerox, GE, Whirpool, and Hewlett Packard, to name a few) have attempted to reduce inventory levels by implementing a just-in-time (JIT) approach production and purchasing. The JIT approach consists of producing products or obtaining products from suppliers at the instant they are required. Since JIT strives to reduce inventory levels, many people refer to JIT as stockless production or zero inventories. BENEFITS OF JIT (BELIEFS BY JIT ADVOCATES) Inventory represents inefficiency: high inventory levels in a company hide sources of inefficiency and causes of poor product quality. Companies often underestimate the holding cost (h) used in EOQ models. In the long run, the cost of a warehouse and the cost of shop storage should be considered as a variable cost and therefore included in the value of holding cost used to compute EOQ. Of course, an increase in h would lower the EOQ, thereby reducing the optimal size and the average inventory level. (EOQ = (2kd)/h) An important determinant of the EOQ is the setup cost k. Often a major component of the setup cost is the time required to set up a machine for a production run. Since a reduction in K will reduce the EOQ and the average inventory level, it is clear that a reduction on K will make it easier to implement JIT. Much of the Japanese success in implementing JIT is due to their reduction in setup times. For example, workers at Toyota can set up an 800 ton punch press (used to produce hoods and fenders) in less than three minutes. Another cause of high inventory levels in American companies is the belief that safety stocks must be held to reduce shortages caused by demand uncertainty and supply uncertainty (such as variability and lead time). JIT reduces the impact of demand uncertainty on inventory levels by levelling the production schedule. For example, if 3000 cars per month, the plant should aim for producing 3000/20 = 150 cars per day. For JIT to succeed, it is critical that the quantity of a product produced each day vary by at most 10% from the average daily production level. By reducing safety stock levels, the causes of supply variability (such as unreliable suppliers and frequent machine breakdown) are exposed. Then supply variability (and therefore safety stock) can be reduced. PUSH AND PULL SYSTEMS (INVENTORIES)

7 To understand how JIT differs from the traditional American approach, we must define two types of production systems Lets consider a manufacturing process in which a product must pass through four workstations before being completed, beginning at station 1 and ending at 4. Think of the product as flowing down a river. Then the first workstation, 1, is farthest upstream, and the final workstation, 4, is the farthest downstream. In a push system, materials push their way through the system from workstation 1 toward 4. Thus, if 100 units of the product are completed at workstation 1, they are then pushed toward workstation 2, causing work for the employees there. Once a unit of the product finishes at workstation 2, it is pushed on to workstation 3, and so on. Many American factories operate as a push system. This can cause huge work-in-process inventories to accumulate. (MRP is a PUSH system)

In contrast, JIT is a pull system, in which an upstream strain does not produce anything unless production is authorised by the immediately succeeding downstream station. For example, workstation 2 cannot work on any material unless authorised by workstation 3. A commonly used implementation of a pull system is the Kanban system.

EXAMPLE 2: What are implications of the JIT approach for supply-chain management?

EXAMPLE 3 Toyota has 35 manufacturing plants in 25 countries (excluding Japan) at which it produces nearly 900,000 vehicles annually. While exports were down by 9 percent in 1993, overseas production was up by 16 percent. In the case of Georgetown, Kentucky, where Camrys are built, Toyota uses the just-in-time concept to supply parts from across the Pacific. The parts are loaded into ocean containers in Japan, shipped across the Pacific, and transferred to trains on the West Coast of the United States for relay to Georgetown, where they feed an assembly line that turns out 1,000 Camrys a day. Deliveries are scheduled to the minute in order to keep inventories low. Due to the long supply lines and the associated uncertainties, supply channels must be more carefully managed than if all production were local.