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  March 2 , 2006 - Supply Chain Digest Newsletter
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First Thoughts by Dan Gilmore, Editor

Supply Chain Network Design in an Era of Dynamic Costs

I had the pleasure in the last couple of weeks of speaking in detail with two of the industry’s real experts on supply chain network design: Jeff Karrenbauer, of Insight, and Mike Kilgore, of ChainAlytics, both heads of their respective companies.

The trigger was my commentary three weeks ago on “SCM and the End of Oil,” where I cited some extreme but increasingly accepted projections that oil prices, and therefore transportation costs, will rise at huge rates over the next few years as demand well outstrips supply.

According to both Karrenbauer and Kilgore, this really does change how you have to think about supply chain network design, in some cases accentuating principles they have long been espousing, in some cases adding some new wrinkles.

One impact is that many companies will need to redo or at least tweak their networks designs more often, Kilgore says. “An increasing number of companies are recognizing the need to replan their networks more frequently, and adjust the strategy on at least an annual basis,” Kilgore said. “The network is very sensitive to changes in business strategy and the operating environment,” he added. “When you combine the constant changes in business strategy with all the uncertainties in the supply chain right now, including the cost and dynamics of transportation, very few networks are good for more than about 12 months.”

Network strategy consultants have for many years complained that too many companies go through the hard work of a network strategy optimization and change, and then don’t think about it again for 3-5 years, until something happens, like a acquisition, or “the pain gets too great.” Is that a luxury very few companies can now afford?

When doing network analysis, the current environment changes the way you have to look at the options, both Kilgore and Karrenbauer agreed. This ultimately bleeds into several other areas, such as supply chain risk reduction strategies, of which oil and transportation cost volatility is really a part.

“You always forecast demand, but now you’ll have to forecast costs in much the same way,” Karenbauer said. “What could look good in the short term could turn out to be really bad under a different set of cost assumptions. In the past, you could use a fairly static level of costs in the model, but now that’s very dangerous. You need to evaluate a number of cost scenarios over multiple periods. That’s not often done.”

I wish we had room for all the insight both gentlemen provided us, but below are a few of the best observations and recommendations:

  • More and more companies may move to hedging transportation costs through the proxy of hedging oil prices. ChainAlytics is actually working with a commodities trading firm to pilot a related service offering. Why? That way, you could lock in a known cost of transportation, and know for a period of time (say a year) that your network assumptions and hence the network itself would be good.
  • You may have to fire some customers, or at least raise their prices to maintain margins. “If transportation costs continue to go up and you can’t pass those costs along fully, those customers may have to be pared, or you have to offer a different level of service,” Karrenbauer said.
  • Postponement strategies are likely to continue to gain momentum. Kilgore notes that if you can reduce the number of manufacturing SKUs that need to be forecast, produced, and replenished to stocking points, it can significantly reduce the cost of transportation, in addition to other benefits. How? As demand and supply variability decrease with fewer SKUs to manage at the back end, companies may be more comfortable using slower, less certain, but less expensive transportation modes such as rail and intermodal to move goods to the network.
  • Private fleets may be under pressure: “Companies are frankly often less than honest about the real cost of private fleets,” Karrenbauer said. “At low operating costs, you can maybe absorb that, but not if oil prices go through the roof.”
  • The trade-offs between inventory and transportation will of course continue to migrate. Until recently, with low transportation costs, the focus was more on inventory reduction. Now, companies will have to rethink that equation, or plan for how to adjust that balance if transport costs continue to soar. “We see a lot more companies today be willing to hold an order to wait to build a better load,” said Kilgore.

That’s all we have room for. At the end of the day, what it says to me is that flexibility – the agile supply chain - is simply more necessary than ever. Let’s all hope we’ll never see $100-$200 a barrel oil, but you sure better have a plan if we do. SCDigest is working with Kilgore on a list of ideas for building flexible networks, which we’ll publish next week.

What do you think of Karrenbauer and Kilgore’s recommendations? Does transportation cost volatility and other factors mean we have to re-optimize our networks much more frequently? How flexible do we need to be? Let us know your thoughts.

Let us know your thoughts.

Dan Gilmore


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Quote of the Week

"They took the Toyota concept of lifetime employment and applied it to the GM culture and what they did was create a bureaucracy. That's what GM does."


Tom Adams, GM jobs bank employee, this week in the Wall Street Journal

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March 2 , 2006
Bear Stearns Quarterly Shippers Survey Finds Supply-Demand Balancing in most Modes, but Continued Price Pressure in Rail

How does your experience match up with responses from hundreds of shippers?


March 2 , 2006

More Users, Less Vapor, at This Year's RFID World 2006

Up attendance, Non-EPC applications, "We're Gen2 now," and three cool new products


March 2 , 2006

SCDigest Technology Editor Mark Fralick's Audio Review of RFID World 2006

What new products caught his eye? Listen now.

March 1 , 2006

Latest Customer Satisfaction Index from the University of Michigan again shows Publix, Kohl’s and Costco at the Top of Consumer’s Perceptions

Supply chain impact on results hard to discern, however


Q.  What do Michigan, Baltimore, Indianapolis, Lockport, NY, and Rancho Cucamonga, CA have in common?

A. Click to find the answer below

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Feedback is coming in at a rate greater than we can publish it - thanks for your response.

We're publishing a few letters that came in from our First Thoughts piece a few weeks ago on "Logistics Costs - Up or Down?" That includes our feedback of the week from Bruce Lewis of Bunzl, who says logistics costs as a percent of sales is not a good measure, and abit of an international feel, with letters from India and South Africa. SCDigest is truly developing an international reach! There's also a letter that says Procter & Gamble (and other companies) should use RFID as a catalyst to really look at its packaging design.

Note we are putting links whenever possible to the original article either in this area or the feedback itself.


Keep the dialog going! Give us your thoughts on this week's Supply Chain topics. As always, we’ll keep your name anonymous if required.

Feedback of the week - on Logistics costs, up or down?

I think is essential to measure logistics costs as an absolute number, because a “percent of sale measurement” distracts a summary metrics viewer from seeing the real migration of the business' cost basis.

The mistake of using percent of sales as a company’s only meaningful metric will become very obvious during the deflationary portion of the cycle.  The escalation of absolute costs can hide in the euphoria of top line growth only to surface as a huge swing in percentage increase when the market and the associated top line falls, even if the absolute cost remains relatively stable.  However, all to often as budget conscious managers we are willing to take the win and the associated credit without acknowledging the windfall aspects of the cycle.

Bruce Lewis


More on logistics costs:

Like many other market determined costs, logistics costs are also a product of the technicals and fundamentals affecting the market.

On the fundamental side, we have the oil prices going up steeply affecting the cost of operations of all transport operators , all of whom heavily depend on the oil products. There has been a limitation earlier on their ability to pass on this increase completely to their customers, but with economies across the globe performing well, this does not seem so much of an issue. Hence the absolute costs are on the rise.

Again last year until mid-2005 we saw International Shipping rates go up steeply, in particular for bulk vessels because of large movement attributed to Chinese commodity trade. Limitation on availability of Handi-max and Panamax vessels played on the market, further fueling the upward freight movement initiated by fuel prices.

On the technical side there has been effect on the market rates attributed to trends and seasons.

Certainly in case of industrial commodities and products, the last year has seen upward movement in price realization, e.g., see the price movement of steel, copper etc. Hence the logistic costs as a percentage of the product cost would have been stable or could have gone down as well. On a global note, since GDP of India and China are on high trajectories and with the developed world also showing growth -though to a lesser extent - logistics costs as a percentage (of GDP) also should be steady or on a minor decline.

T A Krishnan
Larsen & Toubro Limited-India

I read your Supply Chain Digest with interest. I am from South Africa and I read your column everytime since it addresses all the important issues in the logistics/supply chain environment.

This concerns your column on logistics costs. We have recently completed the second of what we call "The Annual State of Logistics Survey for South Africa" - very much along the lines of the US State of Logistics Survey that was initiated by Bob Delaney and which is now being continued by his co-author for the last number of years. In our survey we calculated the annual logistics costs in South Africa to be 15,2 % of GDP. From the US logistics survey the USA logistics costs are 8,6 % - this was the number given in the survey report of June 2005 and is for 2004. The four components that are used for this calculation are transportation costs, warehousing, inventory holding costs and administrative costs. My question is whether there is a source where one can get the comparative costs for all countries. It would be very interesting to get these.

Hans Ittmann

South Africa

On Procter & Gamble's EPC Framework:

Inventory visibility is becoming even more crucial, particularly at the store-level. I did the same thing you did when shopping for a printer during the holidays. It’s not just the e-tailers, but also the bricks & clicks that can benefit from price transparency. In my case, I ordered the product online, but picked it up on the same day at a nearby store because eliminating shipping charges made it cheaper. I also got instant gratification. I only did this, however, because the online site ( was synchronized with store-level inventory on the shelf.

I definitely wanted to avoid the inconvenience of traveling to a store during Christmas only to find the product was out of stock. Absent this integration, I might have purchased from a different vendor with a better total price point (product + shipping). So companies that want to compete with online retailers also have to be better at managing supply, but they also have to look for ways to reduce distribution costs – without increasing delivery wait time. This is especially important for retailers, because organizations are often better at waiting than individual consumers are. I’m know I’m not the only one who wants instant gratification.


D. Scott Beaver

Director, Product Marketing




Q.  What do Michigan, Baltimore, Indianapolis, Lockport, NY, and Rancho Cucamonga, CA have in common?

A. They are all major sites for the auto industry/UAW job bank, where furloughed workers are paid to come each day and sit.

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