Page 278 - DMGT523_LOGISTICS_AND_SUPPLY_CHAIN_MANAGEMENT

Unit 12: Network Integration

Finally, the total cost associated with each location added to the logistical network increases Notes
dramatically. Thus, while the incremental service resulting from additional locations diminishes,
the incremental cost associated with each new location increases: the service payoff for each new
facility is incrementally less.
Logistics managers are often asked to estimate the inventory impact of adding or deleting
warehouses. This relationship between uncertainty and required inventory is called the portfolio
effect. The portfolio effect can be estimated using the square root rule. The square root rule,
originally proposed by Maister, suggests that the safety stock increase as a result of adding a
warehouse is equal to the ratio of the square root of the number of locations in the newly
prepared network divided by the square root of the number of existing locations.

Performance Cycle Modification

Speed and consistency of service can be varied to a specific market or customer by a modification
of some aspect of the performance cycle. To improve service, electronic ordering and premium
transportation can be used. Therefore, geographical proximity and the number of warehouses
do not equate directly to fast or consistent delivery. The decision to increase service by adopting
a faster performance cycle arrangement will typically increase variable cost. In contrast, service
improvement, by virtue of added warehouses, involves a high degree of fixed cost and could
result in less overall system flexibility.
No generalizations can be offered regarding the cost/service improvement ratio attainable
from performance cycle modification. The typical relationship of premium to lowest cost
transportation results in a significant incentive in favour of large shipments. Thus, if order
volume is substantial, the economics of logistics can be expected to favour use of a warehouse or
consolidation point to service a market area.
The impact of using premium transportation will increase total cost. Adjustments from the least
total cost logistical system can typically be justified if the improved service results in increased
revenue.

Safety Stock Modification

A direct way to change service is to increase or decrease the amount of safety stock held at one
or more warehouses. The impact of increasing the safety stock across a total system will shift the
average inventory cost curve upward. A goal of increasing customer service availability will
result in increased safety stocks at each warehouse.

Notes As availability is increased, the safety stocks required to achieve each equal
increment of availability increase at an increasing rate.

12.4.4 Finalizing Strategy

Management often falls into the trap of being overly optimistic in terms of service commitments
to customers. The result may be excessively high customer expectations followed by erratic
performance. In part, such over commitment results from lack of understanding of the total cost
required to support high, zero-defect service.
The final step in establishing a strategy is to evaluate the cost of incremental service in terms of
generating offsetting revenue. To illustrate, assume that the current system is geared to service

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