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The Impact of Oil Price on Supply Chain Strategies. David Simchi-Levi E-mail: [email protected] Professor, Massachusetts Institute of Technology. Chief Science Officer ILOG . Traditional Business Strategies. Lean Manufacturing Outsourcing and offshoring JIT Quick and frequent deliveries.

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the impact of oil price on supply chain strategies

The Impact of Oil Price on Supply Chain Strategies

David Simchi-Levi

E-mail: [email protected]

Professor, Massachusetts Institute of Technology

Chief Science Officer

ILOG

traditional business strategies
Traditional Business Strategies
  • Lean Manufacturing
  • Outsourcing and offshoring
  • JIT
  • Quick and frequent deliveries
  • These strategies are based on assumptions of
  • Cheap oil price
  • Low labor cost in developing countries
increase in logistics costs
Increase in Logistics Costs

Rising energy prices

Rail capacity pressure

Truck driver shortage

Security requirements

15% increase

total us logistics costs 1984 to 2007 billions
Total US Logistics Costs 1984 to 2007 ($ Billions)

Total Cost

52%

47%

Transportation

Inventory

62%

Admin

Source: 19th Annual Logistics Report

impact of oil price on
Impact of Oil Price on…
  • Transportation Costs
  • Network Strategies
  • Transportation Strategies
  • Supply Chain Strategies
relationship between crude oil price and diesel fuel price
Relationship between Crude Oil price and Diesel Fuel Price
  • Trend Line Model
  • Diesel Retail Price(Cents per Gallon) = 2.38515*Crude Oil Price($/barrel) + 132.292
implications on crude oil price to transportation rates
Implications on crude oil price to transportation rates
  • Given the relationship in the previous slide, we see that a $10/barrel increase in crude oil will result in ~$0.24/gallon increase in diesel fuel
  • Standard fuel surcharge methodology is to increase surcharge $0.01/mile for every $0.06 increase in diesel fuel
  • We conclude that for every $10 increase per barrel of crude oil price, we have an additional $0.04/mile increase in transportation rates.
impact of oil price on1
Impact of Oil Price on…
  • Transportation Costs
  • Network Strategies
  • Transportation Strategies
  • Supply Chain Strategies
impact of oil price on network strategy
Impact of Oil Price on Network Strategy
  • Trading off oil price for…
    • Inventory costs
    • Facility costs
    • Manufacturing costs
slide11

Case Study 1: Oil Prices and the Logistics Network

  • Manufacturer of consumer packaged goods
  • Manufacturing is possible in three locations:
    • Philadelphia- Highest production cost
    • Omaha-
    • Juarez, Mexico- Lowest production cost
  • 60 potential DC locations
  • 888 aggregated customers
  • Inbound transportation uses commercial TL carriers
    • TL averages 40,000 lbs/shipment
  • Outbound transportation uses a private fleet
    • Private fleet averages 20,000 lbs/shipment
case study objectives
Case Study - Objectives
  • Determine the best number and location of distribution centers, as well assignment of customers to DC’s.
  • Determine the best allocation of production to their manufacturing locations.
  • Understand how the optimal network would change as oil prices fluctuate
    • Roughly 25% of the supply chain costs are in transportation
discussion of tradeoffs
Discussion of Tradeoffs
  • As crude oil price increases, transportation costs become more important relative to production, inventory and facility fixed costs.
  • Oil price vs. inventory carrying and facility costs
    • Additional DCs are more attractive
      • As outbound transportation becomes more expensive, it becomes increasing important to minimize the distance of the final leg.
  • Oil price vs. production costs
    • Production moves nearer to demand
      • Cheaper manufacturing in Mexico is offset by higher transportation costs.
oil price vs inventory carrying and facility costs
Oil price vs. inventory carrying and facility costs

The Tipping Point

Moving from $125/ barrel to $150/ barrel changes the optimal number of DC’s from 5 to 7. In particular, you can think of Las Vegas being replaced by Los Angeles, Albuquerque, and Portland.

$75/ barrel

$200/ barrel

oil price vs production costs
Oil price vs. production costs

$75/ barrel

$200/ barrel

total cost comparison
Total Cost Comparison

3% increase in total cost

as the price of a barrel

increases from $100 to $150

impact of oil price on2
Impact of Oil Price on…
  • Transportation Costs
  • Network Strategies
  • Transportation Strategies
  • Supply Chain Strategies
changes in transportation strategy
Changes in Transportation Strategy
  • From JIT delivery to better utilization of transportation capacity
    • Larger lot sizes shipped less frequently
    • Efficient packaging to improve truck utilization
  • From quick delivery to cheaper and sometimes slower transportation modes
    • From air to ground
    • From trucking to rail
  • From dedicated to shared resources
    • 3rd party carriers
    • Consolidated warehouses
changes in transportation strategy examples
Changes in transportation strategy: Examples
  • In 2007, S.C. Johnson’ truck utilization project saved the firm “$1.6 million and cut fuel use by 168,000 gallons.”
    • The firm found that mixing loads of Winded glass cleaner and Ziploc bag, which used to be packed in separate loads, better utilizes truck capacity
  • Multiple manufacturers store their products in ES3’ giant warehouse located in York Pennsylvania where truck loads are built and shipped to retailer’s distribution centers.
    • An important benefit of the consolidated warehouse is reduction in transportation costs
impact of oil price on3
Impact of Oil Price on…
  • Transportation Costs
  • Network Strategies
  • Transportation Strategies
  • Supply Chain Strategies
changes in supply chain strategy
Changes in Supply Chain Strategy
  • More Inventory
    • Due to EOS and more DCs
  • Emphasize on better service
    • To reduce expediting costs
  • Less offshoring
    • To reduce total landed costs
sharp moves from offshoring to nearshoring
Sharp moves from offshoring to nearshoring
  • TV manufacturer Sharp has recently started moving manufacturing facilities from Asia to Mexico to serve customers in North and South America.
  • This is driven by the need to keep shipping costs low and time to market short.
    • Indeed, price of flat TV typically falls fast and thus reducing shipping time from about 40 days, when flat TVs were produced in Asia, to seven days makes a big impact on bottom line.
when to move from offshoring to inshoring product characteristics
When to Move from Offshoring to Inshoring? -- Product Characteristics

Cost of Moving Infrastructure

H

L

I

III

Inshoring

Manufacturing

or

Assembly

(TV, Refrigerators,

Appliances, Car

Parts, Furniture)

Offshoring

(Mobile Phone, PC)

Inshoring

(Footwear, Toys)

II

L H

Transportation Impact

toy manufacturer is moving plants near demand
Toy manufacturer is moving plants near demand
  • Steiff, a privately owned German manufacturing company of toys was part of the global outsourcing trend when it moved around 20% of production to low cost countries.
    • The objective was to cut cost and compete on price.
  • Recently, this toy manufacturer started moving production back to Germany, Portugal and Tunisia.
    • The reasons: quality problems together with high transportation costs associated with manufacturing far from the key markets
drivers of moving from offshoring to inshoring
Drivers of Moving from Offshoring to Inshoring
  • Oil Price
  • Labor Cost
  • The value of the dollar

The Average Annual Wage Increase between 2003 and 2008

in different Countries

slide27

US Production Cost per Unit

H

L

L H

Transportation Cost per Unit

(weight, volume, etc)

When to Move from Offshoring to Inshoring

Slope= $ per pound

I

Asia

Mexico

Slope= $ per pound

C

US

A

II

B

case study 2 sourcing strategies
Case Study 2: Sourcing Strategies
  • A large floor covering manufacturer
    • Hardwood, Ceramic Tile,
    • Carpet, Laminate
  • Challenge
    • Understand how increasing laborand transportation costs across the globe are causing previous sourcing decisions to be altered
sourcing parameters
Sourcing Parameters
  • 37,000 SKUs
  • Large range of Production Costs
    • $0.01 to $300 per unit if production is in the US
  • Large Range of Weights
    • 0.01 to 5,000 pounds per unit
  • Manufacturing options
    • US –Atlanta; Mexico – Monterey; China- Shanghai
  • Combination of transport modes
    • Ocean; Rail; Truck Load
costs increase between 2003 2008
Costs increase between 2003 & 2008
  • Labor Costs
    • US ↑ 15 %
    • Mexico ↑ 23 %
    • China ↑ 144 %
  • Transportation Costs
    • Ocean Freight ↑ 100 %
    • TL/Rail ↑ 25 %
    • Good estimate of the increase in rail and TL costs
    • Conservative estimate of the increase in ocean costs
sourcing strategies 2003 and 2008
Sourcing Strategies: 2003 and 2008

SKUs (in orange) moved from China to Mexico

SKUs moved from China to US

your turn
Your Turn!

How to contact me:

David [email protected]

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