Hello, and welcome to this blog on the ILOG Supply Chain Excellence 2008 Symposium. For those who are not here in person in the next two days, I will try to bring the spirit of the conference virtually to you, highlighting and recapping the best portions, and passing along some of the key takeaways.
The conference opened this morning with a moment of silence in remembrance of September 11.
David Simchi-Levi with ILOG then took the stage to offer a brief introduction to ILOG and the company's software tools.
In going into his formal presentation for the conference, "Past the Tipping Point—The Impact of Oil Prices on Supply Chain and Business Strategies", David noted that many traditional business strategies – like lean, outsourcing and offshoring, just-in-time, and quick and frequent deliveries to reduce costs and improve efficiencies in their supply chain – all rely on one assumption – cheap oil. With analysts predicting that oil could resume its upward march and hit as high as $175 or more per barrel, supply chain executives be planning for the new era of high-cost oil.
U.S. logistics costs have increased remarkably over the last few years, to 10 percent of GDP. Transportation costs have increased by 47 percent over the past five years. At the same time, inventory costs have increased by 62 percent as longer lead times, increased safety stocks, larger shipment sizes and other factors have weighed. On the latter point, one strategy that companies have used in the face of higher transportation costs, larger shipment sizes (to take advantage of economies of scale), have had the effect of increasing inventory costs.
David noted that the cost of crude oil has tracked with the cost of diesel over the past four decades. Can we use information about the price of oil to predict the price of diesel at the pump, the cost of shipping and supply chain costs? Yes, the relationship is clear: in the U.S. market, every $10 increase in the cost of a barrel yields a 24 cent per gallon increase in the cost of diesel and an increase in the cost of transportation rates of 4 cents per mile. In Europe, the relationship is more stark, with a $10 increase in the cost per barrel yielding a 12-15 cent per liter increase, depending on the country. Those kinds of increases can easily turn a profitable company into an unprofitable one as transportation costs bite.
How are these cost-increases affecting network strategies? Companies are trading off oil price for inventory costs, facility costs, manufacturing costs and, most importantly, flexibility in the supply chain.
David cited case studies illustrating this point. For example, a manufacturer with country-wide demand and three manufacturing facilities (in the Midwest, the East and Mexico) needed to consider the impact of transportation costs in planning its network of distribution centers. Using optimization tools, the company was able to determine that its optimal strategy was considerable different at $75/barrel for oil than for $200/barrel. The company noted that the strategy did not change from $75/barrel up to $150/barrel, but $150/barrel was the tipping point – the point at which it made sense for the company to change its network strategy.
The point is not that $150/barrel is going to be the same tipping point for every company. In fact, every company will have its own tipping point, and to plan for increased cost of oil, each company must understand where its own tipping point is.
On the question of trading off oil price for flexibility, David cited the example of a European consumer packaged goods company. The company had to determine the best location for DCs and best allocation for product to their manufacturing locations. Again, the company "what-iffed" the best network at $100 and $200 per barrel. Initially the best solution was to add DCs in response to increased oil costs, going from 10 to 14 DCs as oil went from $100 to $200 per barrel, representing an increase of costs of 14 percent. But when the company also considered the tradeoff between manufacturing efficiency (each plant specializing in a few products) and manufacturing flexibility (each plant capable of producing a variety of products), at $200/barrel, the best solution for this company would be to add manufacturing lines to be more flexible – that would allow the company to add just one DC to the network, resulting in cost increases of 3.5 percent versus about 14 percent that would have resulted if the company had focused solely on adding DCs.
Concluding on this theme, David suggested that companies will shift from JIT deliver to better utilization of transportation capacity, with larger lot sizes shipped less frequently, and efficient packaging to improve truck utilization. He also sees companies moving from quick delivery to cheaper and sometimes slower transportation modes, such as from air to ground and from truck to rail; moving from dedicated to share resources through greater use of third-party carriers and consolidated warehouses; and less offshoring to reduce total landed costs. This latter point is already illustrated by companies like Sharp, which has recently started moving manufacturing facilities from Asia to Mexico to serve customers in North and South America.
And, finally, David touched on green issues. Surveys show that green is getting more attention in executive suites, in part as companies realize that a high carbon footprint is a sign of an inefficient supply chain. Wal-Mart, for example, has set significant goals for reducing the carbon footprint of its overall supply chain and is pushing those goals down onto its suppliers and service providers. Dell, another example, is changing transportation from air to ground using a network optimization tool, in the face of the fact that air generates seven times higher carbon emission levels than ground.
David also ran through an example illustrating that using optimization, companies have the opportunity to understand the optimal supply chain from a carbon footprint perspective and understand the cost of reducing their carbon footprint.