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March 20, 2008 - Supply Chain Digest Newsletter
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First Thoughts by Dan Gilmore, Editor

Oil Prices and Supply Chain Network Design

Last week, I discussed the topic of supply chain and where it appears we could be headed – oil prices at $150 or even (gasp) $200 per barrel. It generated a lot of reader feedback, which we will publish soon. (See Supply Chain and $200 Oil.)

Gilmore Says:

"The bottom line of the analysis – for this one company, at least, rising oil and transportation costs would impact profitability, but not core supply chain design, for the first few $25 increments in rising oil prices. But when you hit $150 – things really start to change."

What do you say?

Send us your comments here

Many of the cost impacts are easy to project. But how would it really influence supply chain network design?

That’s the question I recently ask Dr. David Simchi-Levi, one of the industry’s most recognized thought leaders. For many years, Simchi-Levi has been a professor at MIT. He has written several books and dozens of articles on supply chain, and was founder of Logics Tools, a provider of network design and related software that last year was purchased by ILOG.

Dr. Simchi-Levi volunteered to take a look at the impact of rising oil prices using data from a real consumer goods company. We are very pleased to be able to share the results with you here.

“This turned out to be a very interesting question. The results are not obvious,” Simchi-Levi told me.

Last week, I did my own “back of the envelope” calculations on how diesel and truckload freight costs would rise as oil went to $150 or $200 per barrel. Dr. Simchi-Levi did a related analysis, looking back over many years. His conclusion: diesel prices rise about 24 cents per gallon for every $10 increase in the price per barrel of oil. With carrier fuel surcharges running at something like a 1-cent increase for every 6-cent increase in diesel prices, Dr. Simchi-Levi concludes that for every $10 increase per barrel of crude oil price, there is an additional 4-cent per mile increase in transportation rates. This is the data he uses as the basis for his supply chain network analysis.

For the scenario analysis, Dr. Simchi-Levi took actual supply chain network data from a real consumer packaged goods company. The firm has three potential manufacturing locations – highest cost production in the Philadelphia area, slightly lower costs at a plant near Omaha, and lowest cost production in Juarez, Mexico. In its model, the company is evaluating 60 possible locations for distribution centers. Oil at $75 is used as the baseline oil price.

The bottom line of the analysis – for this one company, at least, rising oil and transportation costs would impact profitability, but not core supply chain design, for the first few $25 increments in rising oil prices. But when you hit $150 – things really start to change.

“At that point, rising transportation costs start to significantly impact both where products are made and what the distribution network looks like,” Dr. Simchi-Levi told me.  “At that point, the rise in transportation costs starts to impact the trade-offs with manufacturing costs and the trade-offs with inventory costs. For example, it might be better off holding more total inventory by having more distribution centers in the network so you can get closer to customers and reduce outbound shipping costs.”

Based on total supply chain cost, for example, with oil at $75 the optimal manufacturing mix is to produce 22% of this company’s goods in the Philadelphia location, and 78% in Juarez. At $200 oil, however, the Philadelphia plant’s share rises just 1 point, to 23%, but Juarez’s share drops to just 54%, while Omaha enters the picture at 23% of total production. This happens because for many of the company’s internal moves, the higher manufacturing costs in Omaha would be offset by lower transportation costs versus Juarez.

On the DC network side, things are similarly interesting. As oil goes to $100 and then $125, the optimal network design stays the same, with five DCs (Atlanta, Chicago, Dallas, New York and Las Vegas).  But at $150, there is a dramatic change – the optimal network uses seven DCs, as transportation costs reach an inflection point. The Las Vegas DC is out, replaced with new facilities in Albuquerque, Los Angeles and Portland, as shown in the graphic below.

Click on Image for Larger Version

You can find an excellent slide deck detailing this analysis, courtesy of Dr. Simchi-Levi, on the SCDigest web site: Analysis of Rising Oil Prices on Supply Chain Network Design.

So what are the key takeaways? Dr. Simchi-Levi offers some thoughts:

  • “This really makes the initiatives around reducing carbon emissions very interesting,” Dr. Simchi-Levi said. “Carbon emissions are clearly related to energy use. By reducing carbon emissions, companies will also be reducing the impact of rising oil prices. We need to de-couple or reduce the correlation between rising oil prices and supply chain costs.”
  • He expects rising oil prices would have the effect of changing the way we think about outsourcing and offshoring, after 10 years of a mad rush to China and other Asian locations. “I would especially expect Mexico to become much more attractive,” Dr. Simchi-Levi says.
  • In this era of dynamic costs and rapidly changing markets, companies must monitor and re-evaluate their networks on a much more consistent basis. Formal scenario and risk analysis is critical to that effort, he says. While no one knows where oil prices will go, as just one example, you need to understand what the impact would be, and make decisions that optimally considers risk and potential changes. This may often mean trading somewhat higher base supply chain costs for much greater flexibility down the road.
  • By the way, even fully optimized, total supply chain costs rise 3% if oil goes to $150 for the consumer goods company. With the supply chain representing 70-80% of total costs for most companies, that would be a huge impact to the bottom line, depending on how much sell prices could be increased in the market.

That’s all we have room for. Thanks to Dr. Simchi-Levi for his efforts (which I know took a lot of time) for the benefit of SCDigest readers.

Anything surprise or strike you in Dr. Simchi-Levi’s analysis? How do you think about this problem? What is the right balance between cost and flexibility? Let us know your thoughts at the Feedback button below.

Let us know your thoughts.

Want a printable version? Go to:


Dan Gilmore


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This Week’s Supply Chain News Bites – Only from SCDigest

March 20, 2008
Supply Chain Graphic of the Week - The Incredible Rise in Diesel Prices

March 20, 2008
Supply Chain by the Numbers: March 20, 2008


It was another roller coaster week on Wall Street ending in an overall slight decline.  Our Supply Chain and Logistics stock index saw vastly mixed results.

In the software group, Logility rebounded from a portion of last week’s slide (up 16.1%) and Ariba also saw double-digit gains (up 11.5%). In the hardware group, both Intermec and Zebra were up for the week (0.3% and 2%, respectively).  In the transportation and logistics group, Yellow Roadway was down 8.9%, while Ryder finished the week up 7.4%.    

See stock report.


Each Week:

-Global Supply Chain
-Distribution/Material Handling
-Trends and Issues

Weekly On-Target Newsletter
March 18, 2008

Discussion Question

Test Explores Ability of RFID to Fight Shoplifters

Do you see a significant opportunity for RFID technology to help curtail shoplifting in retail stores?


Q. To what location did Dell recently move its logistics services group headquarters?

A. Click to find the answer below


Reader Question: Can Bucket Brigades Work with Mechanized Order Picking?

Reader Question: Is there a True Global RFID Standard?

See our expert answers at the links above. Share your knowledge or perspective.

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We're really behind again - bear with us. But keep the letters coming! In the next few weeks, we'll start adding feedback right on specific story pages, so you can see what others are saying.

The Feedback continues to come in at high levels.

We received a substantial amount of outstanding feedback (which is still coming in) on our piece on “The Real Barriers to 3PL and Contract Manufacturer Collaboration.”

We publish a few of the first letters we received here. That includes our Feedback of the Week from Nicholas Seiersen of KPMG, who agrees that these barriers sometimes exist, but thinks that’s bad for both sides. Steve Murray of Supply Chain Visions says it was interesting to see us reference another “Elephant in the Room,” while Dwight Boehm of CF Managing Movement says we need more listening and less talking. Finally this week, David MacLeod of Learn Logistics Limited says the issue can benefit from some interesting verse from 100 years ago.

All good comments; more on this topic next week.

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

Feedbacks of the Week - On Barriers to 3PL/CM Collaboration:

Your piece on getting value from the LSP relationship is thought provoking as usual. With the size of the LSP industry, there is no one relationship model out there. Some are more open or collaborative than others, and that is a factor of such things as:

  • Who is managing the relationship (from both sides), and how are they recognized? If you have a slick salesman on the LSP side and a weary middle management survivor of the post-outsourcing downsizing, you will probably have a hostile, static relationship. If you have rising star executives on both sides who understand that it is important to deliver tangible value rather than sizzle, the relationships will probably drive real progress.
  • What is the nature of the contract? If the contract is written so that the LSP is kept whole on their profit or management fee when they save money, and they even get a portion of the savings for helping design and make it happen, then progress will probably happen.
  • How do both parties work to keep strategic alignment over the course of the contract and beyond, through the renewals discussions? Like any relationship, neglect breeds divergence, and subsequently contempt. In research we recently conducted, good renewals start long before the contract expires, and then make sure the deal is right for both parties and what they are trying to achieve, particularly in the light of 3 to 5 years of shared experience and a very different business and economic backdrop. The renewal is an opportunity to really fix the things that were not worked out completely at the outset, and re-align the arrangement to the new business realities.

As Gene Tyndall says, the LSP should always bring ideas to the table, but if they are not given due consideration, or their implementation will dig a hole in the bonus, don’t hold your breath…

As to hoarding information, it feels like that is either the product of a closed mind, or an arrogant mind – the more people you have thinking about problems and opportunities, the better the solutions you will find. If you don’t trust your LSP (distribution partner and expert) to challenge your thinking constructively, there is probably missed opportunity in the relationship.

These opinions are mine and not necessarily those of my employer.

Nicholas Seiersen, MBA, P.Log.
Senior Manager

More on 3PL/CM Collaboration:

Oh yes, the “Elephant in the Room." How far to take collaboration? I think that we can all agree that if a supply chain is to be truly Lean and efficient, with all of the non-value added elements removed so that the customer is receiving the most value possible, we need full and open collaboration. But Dan is spot on, this typically will not happen due to the want/need to keep cards close to the vest on the part of the customer, and the desire to maximize business and profit on the part of the supplier. Suppliers want a profitable 100-year relationshi; customers want to be able to switch partners at the drop of a hat for a variety of reasons.

Dan has focused on the contract manufacturer/outsourcing relationship, but the same is true in virtually any supplier/customer relationship.

The goal is absolute teamwork between the parties. “If one wins, we all win” kind of thinking. Pretty hard to achieve, but not impossible. Toyota has been able to do this in large part because of the Japanese "Keiretsu" business relationships, which include cross-ownership, etc. US regulatory requirements sometimes also prevent too close of a relationship. Dan refers to a strategic business relationship as code for “get more business” and unfortunately this twisted version of thinking is way too common. Howeve,r until we can figure out a way to get truly and honestly strategic in our relationships, the concept of collaboration cannot yield its true potential.

Steve Murray
Principal and Chief Researcher
Supply Chain Visions

Unfortunately, too many people think collaboration is "I talk" and then "You listen and do." For collaboration to work, all parties need to understand what is important to their partners and why? Then they must set about to meet their needs. If all parties do this, you create the "Win/Win/Win" that entrenches collaboration as a key to not only ongoing success, but also to ensuring your companies continued survival. The moment you focus exclusively on your own interests at the expense of others, you get further away from you goal of optimizing your companies performance.

Dwight Boehm, P.Log
Manager, Solution Design
CF Managing Movement

An excellent contribution getting right to the key issues.

In my view, the approach by both parties, client and service provider, has been dominated for too long by a blinkered concentration on analyzing/negotiating the “AS IS” cost and delivering the perceived “TO BE” cost. No quality time is spent on the “SHOULD COST” – what the real potential is. Why this is the case is an interesting area for debate/discussion but I feel that John Ruskin put his finger on the reason over 100 years ago when he said:

It is unwise to pay too much, but it’s worse to pay too little.
When you pay too much, you lose a little money - that is all.
When you pay too little, you sometimes lose everything, because the thing you bought was incapable of doing the thing it was bought to do.
The common law business balance prohibits paying a little and getting a lot - it can’t be done.
If you deal with the lowest bidder, it is well to add something for the risk you run.
And if you do that, you will have enough to pay for something better”

David MacLeod
Learn Logistics Limited


Q.To what location did Dell recently move its logistics services group headquarters?

A. Singapore, from its Round Rock, TX headquarters.

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