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December 14, 2017
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Time for a checkup?

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If you haven't improved your logistics network for a while, it might be time for an examination. Here's a five-step method that can cut logistics costs by 10 to 20 percent.

If your company has not made substantial changes to its logistics functions in several years, it may be time for a checkup. Given today's dynamic business environment, it is more important than ever to periodically re-evaluate a company's network by comparing its services and performance to the requirements of customers and markets.

This evaluation—known as a "logistics audit" or "potential analysis"—examines the capabilities and capacities of operating locations, logistics processes, and the structure of the entire logistics network. Figure 1 shows one example of the locations, services, and relationships that could be subject to this type of audit.

Article Figures
[Figure 1] Possible areas of improvement in a consumer goods logistics network
[Figure 1] Possible areas of improvement in a consumer goods logistics network Enlarge this image
[Figure 2] Sample process-analysis checklist
[Figure 2] Sample process-analysis checklist Enlarge this image

A logistics audit has three main objectives:

  • to discover the areas that provide the greatest opportunities for improvement,
  • to identify the weak points and potential ways to address them, and
  • to assess the economic value of improvements, including cost savings.

Depending on the company's current situation, an audit can produce potential savings of between 10 and 20 percent of its total logistics costs. In specific areas and under certain circumstances, the potential savings can be even higher. Even a savings of 10 percent can have a notable impact on profits. Consider: For a company with an operating margin of 2 percent, where logistics represents 10 percent of the total costs, a 10-percent reduction in its total logistics costs will result in a profit improvement of 50 percent. This level of savings is always welcome, but in times of financial crisis it is likely to be especially attractive to top management.

This article, which is adapted from our book, Comprehensive Logistics,1 will explain how to conduct a logistics audit by completing the following five steps:

  1. requirement analysis
  2. performance analysis
  3. process analysis
  4. structure analysis
  5. benchmarking

Depending on the size of the company, these steps can take between four weeks and three months to carry out. Thanks to the resulting cost savings and increased profits, companies generally can expect to achieve a return on investment in less than one year.

Step 1: Requirement analysis
The first step is a critical assessment of the logistics services and performance levels required by customers, markets, and internal departments such as sales and marketing. The audit team should answer the following questions:

  • Are the current requirements for logistics performance necessary, given the overall service goals of the company? For instance, is it necessary to offer 24-hour delivery if only a few customers require this level of service? Another example: Is it necessary to permanently offer the highest level of production capacity and stock availability if it is only required during peak times?
  • Do the benefits of fulfilling those requirements outweigh the costs?
  • Are you prioritizing correctly? Are you providing sufficient service to your most important market segments? Do the most profitable customer segments get the best service?
  • Are the current assortment of articles—parts, products, or merchandise—and the range of services adequate? Are they too diversified? Does the assortment include unprofitable articles or services that could be eliminated without affecting the company's competitive position?
  • To what extent could logistics services and quality be reduced, and what would be the consequences of such a reduction?

When analyzing your requirements, it can be helpful to keep in mind the adequacy principle:

The cost of providing any service improvement must be measured against the additional sales and profit that can be achieved as a result of that improvement.

For example, it may not be worth the expense to offer 24-hour delivery to every customer, or customers may demand higher reliability levels than you can provide at costs that are acceptable to you.

By revealing the costs and benefits of various logistics service levels, the requirement analysis can help you address one of the major conflicts within a company: What the sales organization promises versus what operations can actually do. If salespeople are ignorant of the costs to provide a logistics service, it will be tempting for them to set a goal of 100-percent delivery availability, even though an average availability of 98 percent may be good enough. For example, if you make the costs of providing special services clear to the customer, perhaps by explicitly charging an express surcharge or a packaging fee, you may find that many customers will decline those services, and you can adjust service requirements accordingly.

After examining the requirements, the audit team can recommend a balanced assortment of articles and services, establish what service levels are adequate, and develop differentiated quality standards.

Step 2: Performance analysis
In the next step, the auditors examine how well the operative and administrative "stations" and "performance chains" of the logistics network—including procurement, production, distribution, and sales—fulfill those requirements, and at what cost. A "station" can be a single physical location, such as a warehouse or distribution center, transshipment point, manufacturing plant, or sales office, where orders, materials, and resources enter as inputs and products or services leave as outputs. A "performance chain" is a series of linked stations that executes specific functions.

For each station, the team should determine the performance limit—that is, the maximum possible throughout or output; the operating, processing, and throughput times; the available size and space; the location of resources, facilities, and stocks; and the buffer and storage capacities. By conducting an inputoutput analysis of the stations, or locations, it is possible to see what resources are required and what it costs to fulfill an order. Through this analysis, the team can identify which locations are not performing in an optimal manner; they can then develop initial ideas for improving, strengthening, or even eliminating these weak points.

The following are some common types of problem areas that can cause process delays and increase performance costs:

  • Bottlenecks are stations with insufficient capacity, which operate in peak times above 95 percent of their performance limit. They cause long queues and waiting times for incoming orders, material, and/or logistics units, such as parcels or pallets. This can limit the output of a system, network, or even the whole company.
  • Excess-capacity stations operate for long periods below 70 percent of their maximum throughput or output. Even in peak times they do not reach capacity. Often they are overstaffed and drive up costs without generating value.
  • Failure points have an availability level far below 90 percent. They cause frequent or long-lasting interruptions that block upstream stations in the supply chain. They also cause downstream locations to be underutilized and can be the source of severe delivery delays and missed deadlines.
  • Redundancy stations that duplicate the functions performed at one or more other locations in the network are generally necessary in order to have alternatives if a breakdown should occur. However, companies should assess whether the existing degree of redundancy is really necessary.
  • Delay points greatly exceed required throughput times and completion dates. They are often bottlenecks or failure points that put promised delivery dates at risk and cause additional costs downstream as the supply chain tries to make up for lost time.
  • Fault points cause serious errors with unacceptable frequency. They negatively affect performance and costs by causing delays, disturbances, inefficiencies, rework, and extra effort at subsequent stations in the supply chains.
  • Main cost areas generate the greatest share of the total logistics costs. These areas offer the largest potential savings, which can be achieved by reengineering, improved organization, rationalization, mechanization and automation, and/or advanced information technology.

Step 3: Process analysis
Companies must assess not only the performance within the various stations of the supply network but also the flow of orders and material between those points. To assess the end-to-end flow of orders and material, it is necessary to document and review the existing order, logistics, and performance processes.

The process analysis begins with order acceptance, followed by order scheduling, procurement, production, and distribution. The last step involves delivering the product or service to the customer. However, when assessing logistics processes, it is advisable to apply the following rule:

Scrutinize the order processes by following the order flow, but analyze the logistics processes against the flow of goods.

Starting the analysis of order processes with the customer ensures that the analysis will assess the real value contribution and customer orientation of each of the stations that will be involved. Analyzing the flow of the logistics units (the shipments, load units, or individual items) upstream, from their destinations to their sources, helps to reveal the goal orientation of the individual process steps within the supply chain.

Figure 2 presents a checklist of the most important subject areas and questions to be asked during the process analysis. (For more questions, precise definitions of the terms, and detailed explanations, please consult our book, Comprehensive Logistics.)

The process analysis results in recommendations for process optimization and more efficient use of resources as well as outsourcing decisions. It also is a useful means of estimating the economic value of potential changes.

Step 4: Structure analysis
After analyzing logistics requirements, performances, and processes, the audit team next should examine whether the current structure of the logistics network satisfies present and future demands. For this purpose, the team must map out the company's network and all subsystems of interest. (See Figure 1 for an example.) During the structure analysis, the following questions need to be answered:

  • What is the optimal number of plants, storage locations, logistics centers, delivery points, and sales outlets?
  • Are the plants, storage locations, logistics centers, transshipment points, and delivery points optimally located?
  • Are the functions, tasks, and inventories correctly allocated among plants, logistics centers, and trans–shipment points?
  • Which functions should be executed centrally,and which should be executed locally?
  • How would consolidating local inventories and functions at a logistics center reduce costs and improve performance?
  • What is the optimal number of stages for procurement and distribution?
  • Are there avoidable handling or transfer activities?
  • Are the right criteria applied for choosing direct delivery or delivery via transshipment points and logistics centers?

The structure analysis may produce suggestions for improving or redesigning parts of the network or even the entire logistics network. It also offers proposals for centralization or localization of various functions and inventories. The analysis should give you an idea of how the proposed recommendations will improve costs, service, performance, and competitiveness.

Step 5: Benchmarking
Benchmarking is the final step in the audit process. By benchmarking, we mean the comparison of costs, performance, quality, and other key performance indicators among several companies, business units, or supply chain stations with similar activities and functions. It can also include a comparison of operational methods, organization, and strategies.

But benchmarking can be tricky. It is essential that the business units being compared have similar tasks, functions, and key performance indicators, as relatively small differences between companies, plants, or even single operative stations can lead to quite different key performance indicators (KPIs).

External benchmarking compares the key indicators of different companies' performance units. It is difficult, however, to ensure that they are truly comparable. For example, benchmarking against another company's reported logistics costs as a percentage of revenue can be misleading, as companies define and record those costs differently. Moreover, due to differences in products' size and value, logistics costs that relate to the value of the goods on a pallet or other load unit can differ by a factor of 10 or more, even when the logistics costs per load unit are equal.

In addition, the results of external interviews or trend surveys can be misleading because they do not necessarily reveal the specific circumstances and goals of the other companies. The answers you get, of course, reflect the opinions, competence, and intentions of the people who participated in the interviews or filled out the questionnaires; they are unlikely to give deeper insight into their companies' performance and strategies. Even if all participants answer honestly and in-depth, the value of external benchmarking remains debatable. Companies that only follow trends and other companies' examples will be simply average and inevitably will make the same mistakes as others. In order to become the best in class and to have a lead over competitors, a company has to develop its own, unique strategies.

Internal benchmarking within the same company compares the key performance indicators of operations and administrative offices that have similar tasks and functions. For this reason, it can only be carried out in larger companies that have several operative stations of the same kind. The advantage of internal benchmarking is that it allows you to assess whether the stations' goals, assigned tasks, and functions are sufficiently similar. It also allows you to make sure that the KPIs are defined and measured throughout the company in the same manner. In short, internal benchmarking shows how well the compared plants, storage locations, or logistics centers fulfill their jobs and the degree to which they differ in costs and performance.

An even better approach may be analytical benchmarking, which compares the key performance indicators of an existing business unit with those of an optimally planned and organized unit—in other words, comparing current performance against the ideal. Analytical benchmarking allows companies to recognize their options, assess the changes that will be needed to make improvements, calculate the costs and investments required, and identify the necessary actions needed to achieve the options that have been identified. It requires companies to develop their own strategies and company-specific solutions.

From a medium-term perspective, analytical benchmarking helps companies see how they can improve their current performance. It can also help them beat external competitors and achieve sustainable competitive advantage by leaving the common path of following a "me too" philosophy or industry "best practices" without assessing whether they are suitable for their own operations or goals.

Closing the gap
There continues to be a gap between logistics theory and business practice in terms of knowledge and execution. Accordingly, logistics practices at most companies still offer a great deal of room for improvement. A logistics audit, such as the five-step approach described in this article, provides a method for discovering those possibilities.

However, it is important to remember that the logistics audit by itself does not offer solutions. Only strategies, which are procedures for reaching a certain goal, can help to find the optimal solution. Once an audit has been completed, companies can realize the potential improvements they discovered during the logistics audit by implementing solutions with the help of rules and tools designed to optimize their logistics performance.


Endnote:

1. This article is based on Chapter 4 of Comprehensive Logistics, by Timm Gudehus and Herbert Kotzab. The 891-page book (ISBN: 978-3540- 30722-8), published by Springer in 2009, includes 282 illustrations.

Dr. Timm Gudehus of Hamburg (Germany) is a consultant and author in logistics, strategy, and other areas. Dr. Herbert Kotzab is professor in the Department of Operations Management of the Copenhagen Business School.

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