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ISyE 6203 Transportation & Supply Chain Systems. John H. Vande Vate Fall 2011. What aspects of the financial goals of the organization do Supply Chain activities contribute to? How do we measure these aspects of Supply Chain activities?

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Isye 6203 transportation supply chain systems

ISyE 6203Transportation & Supply Chain Systems

John H. Vande Vate

Fall 2011


My approach

What aspects of the financial goals of the organization do Supply Chain activities contribute to?

How do we measure these aspects of Supply Chain activities?

Financial goals often conflict. What tools are available to help Supply Chain find the right balance

What tools are available to help improve SC performance

Motivate by simple examples

Integrate via an industrial project

My Approach



That we understand the main SC objectives Supply Chain activities contribute to?

That we can assess the effects of proposed initiatives on those objectives

That we develop some skill and intuition for identifying effective initiatives

That we are armed with some practical tools for designing, balancing and optimizing SC activities.

That we have some real experience doing all of these



Deterministic vs stochastic

Organizations are adept at managing forecasted flows Supply Chain activities contribute to?

Most still struggle with forecast (in)accuracy and unforecasted variability

We will start with a deterministic view through the mid-term.

Focus on managing variability after the mid-term

Deterministic vs Stochastic


Project teams

We will work in teams of 4-5 on a project and on improving “Our Company” performance

You should select your team members by Thursday, September 1st end of class

One person from each team should send me an e-mail with the subject line 6203 Teams with

The names and contact information (e-mails and phone numbers) of the team members

Resumes of all the team members

T-Square User IDs of the team members

Project Teams


The projects

Dell – Confirmed but evolving “Our Company” performance

Project 1 Optimization of the 3rd Party Distributor network

Project 2 Optimization of FedEx Ground and FedEx Home networks

Project 3 Sensitivity of network to cost drivers, eg pallet weight

Project 4. Returns network

UTi – 3PL and Freight Forwarder

How much capacity on a lane should we secure via block space agreements

How would a change in the variability of a customer’s actual freight volumes (weight and cube) affect UTi’s profitability on that lane

The Projects


The projects1

Audi “Our Company” performance


The Projects


Project structure

3 Steps (Adaptable) “Our Company” performance

Step 1: Formal project statement, summary of the data and rough estimates of the potential impacts of various alternatives.

Step 2: Analyze and optimize the top alternatives and develop detail assessments of their cost and service impacts

Step 3: Present your assessment and recommendations to management, including an evaluation of more qualitative risks and opportunities associated with each strategy.

Project Structure



Each team will make a 20 – 30 minute presentation to me for each step.

Each team will make at least one presentation to the class (most will present the final project)

Each team will present to the client (probably via phone or internet)

An organized CD or T-Square files that facilitate the transfer of your project.

I will set up Team Project Forums on T-Square



First steps

Organize your team for each step.

Introductory conference call with sponsor (working to schedule these the week of Sept 5. TBA)

First Steps


Conference calls

We will schedule roughly bi-weekly conference calls with our sponsor.

Usually in 226 (arranged via Meka Wimberly

Not necessary that everyone be there, but it’s better.

Someone from you team should take careful notes and post them as meeting minutes on the Project Forum

You are responsible for organizing conference calls.

Conference Calls


Course organization

Two Exams sponsor.


Final: Tuesday, December 13th from 11:30 – 2:30


Project 30%

Mid-term: 30%

Final: 30%

Team Presentations: 10%

Warning: People struggle with my exams

Academic Honesty

Course Organization


Isye 6203 transportation supply chain systems

No text book. sponsor.

I’ve listed some good resources on the class web page (see T-Square)

I will provide selected readings and links to additional information

Radical Tools (an Excel Add-in) in the Labs

MapPoint 2010 available for free from

I believe it comes as a DVD and so takes time to deliver. Please let me know if you learn otherwise.




Feel free to send questions via e-mail sponsor.

Or drop by my office: 222 of old ISyE bldg

Feel free to schedule a meeting via e-mail

Anonymous feedback on each lecture via T-Square (under Tests & Quizzes – I used “Anonymous grading only” so I don’t see your identity).




I have to be out of the country from September 10 through 22nd

I will arrange three guest lectures during that period

One classes set aside for team project meetings



Our company

Today: Introduce Our Company and evaluate its performance sponsor.

Coming Weeks: Develop a distribution strategy to improve Our Company’s financial performance

These will be Team Presentation Assignments

Our Company



Products: sponsor.

Computers: CPU, Monitor

Televisions: TV and Console


100 across the US

Sell 10 TVs and 10 computers per day

250 days/year



Components sponsor.

We assume a

truck holds 30,000 lbs and travels 500 miles/day


Current operations

All direct shipments in full truckloads sponsor.

Current Operations



Shipments on the order of 1,000 miles sponsor.


Use your head!

Make an estimate.

Refine it.


Green Bay: 969

Indianapolis: 854

Denver: 1,006


Our company xls
Our Company.xls sponsor.

  • Enable Macros

    • ArcCos

    • Distance: Computes the distance in miles between two latlong coordinates

    • Or you can use the Radical Tools add in available in the labs. (We won’t work with distance much initially)

  • Components: Cost, weight, source

  • Products: BOM, Selling price

  • Locations: LatLongs of stores and plants, distances

  • Financials: Income Statement, Balance Sheet, Metrics


Our company xls1
Our Company.xls sponsor.


Our company xls2
Our Company.xls sponsor.


Arrow electronics annual report

“Operating efficiency and sponsor.working capital management remain a key focus of the company's business initiatives to grow sales faster than the market, grow profits faster than sales, and increase return on invested capital.”

Arrow Electronics Annual Report

Market Share


Return on invested capital


Sc finance
SC & Finance sponsor.

“Corporation managers generally claim that they have four broad responsibilities: to consumers, to employees, to stockholders, and to the general public … each group is on an equal footing: the function of management is to secure justice for all and unconditional maxima for none. Stockholders have no special priority; they are entitled to a fair return on their investment, but profits above a ‘fair’ level are an economic sin.”

Sutton et al. The American Business Creed 1956


Financial goals

Income Statement sponsor.

Balance Sheet

Financial Goals



SC helps drive revenue sponsor.

Superior service commands higher price and loyalty

Product availability drives sales

Integrated operations can become a barrier to changing suppliers

Speed of product introduction can win market share

Our Company: Revenues = $450 Million




COGS: Cost of Goods Sold sponsor.

Includes all costs of material, labor, and allocated overhead, purchase, conversion and other costs incurred in bringing the inventories to their present location and condition.

Prices change. So there are various methods for reconciling:

specific identification,

first-in first-out (FIFO)

average cost

That’s accounting, we won’t worry to much about the accounting standards.



Isye 6203 transportation supply chain systems

You can read more about COGS at sponsor.

Or for a quick practical overview,

Our Company COGS consists of

Raw Materials: $300 Million

Labor: $1.41 Million

Transportation: ?


Not required

Not required


Gross margin
Gross Margin sponsor.

  • Gross Margin = Revenue – COGS

  • Gross Margin as % of Sales =

    Our Company: Low transportation costs ensure high Gross Margin

    For more details see

Not required


Isye 6203 transportation supply chain systems

SG&A: Selling, General & Administrative includes costs for research and development, product design, marketing, distribution, customer service, commissions, administration, and overhead.

Our Company: SGA = $26.2 Million

For more discussion see, for example,


Not required


Depreciation amortization

Typically not a major SC consideration for us. Has to do with expensing large capital asset investments like plants and equipment

Except for Depreciation, Profitability is driven by revenue and operating EXPENSES

Depreciation & Amortization


Operating income ebit

Earnings Before Interest & Taxes with expensing large capital asset investments like plants and equipment

Gross Margin minus


Amortization & Depreciation

Impairments and other expenses

Operating Income (EBIT)


Balance sheet capital utilization
Balance Sheet: Capital Utilization with expensing large capital asset investments like plants and equipment


Why capital utilization

Might find “Capital Productivity: Why the US Leads and Why it Matters” interesting.

McKinsey Quarterly, 1996 Issue 3

Available from eJournals at

Focus on “Why it Matters”. Might be interesting to reflect on the “Why US leads” aspects in light of financial crisis.

Why Capital Utilization?

Not required


Digression on us vs german capital utilization

Differences in capital markets it Matters” interesting.

Differences in employment models

Differences in political economies

A broader perspective on “goldplating”

Digression on US vs German Capital Utilization


Capital utilization

“Productivity” of capital it Matters” interesting.

How well capital investments are employed to deliver goods and services

From an investor perspective, related to the return available from investment

Note the INVESTMENT perspective.

Capital Utilization driven by Revenue and INVESTMENT

Capital Utilization


Productivity of capital
Productivity of Capital it Matters” interesting.

  • Productivity of Capital (SPEED)

  • Return on Invested Capital (ROIC)

  • Our Company: Reducing Inventories improves SPEED and ROIC

  • For more information see


Not required


Nopat nibcls

NOPAT: Net Operating Profit After Taxes it Matters” interesting.

NIBCLs: Non-interest bearing current liabilities, eg., accounts payable



Two kinds of capital

Fixed Capital Assets it Matters” interesting.

Plants and Equipment

Working Capital

Inventories or raw materials and finished goods

Accounts receivable

Accounts payable

For more on Working Capital see

Two kinds of Capital

Not required


Working capital

The cash required to finance operations it Matters” interesting.

The Cash-to-Cash cycle

Organization must have capital to fund raw materials, etc. from the time it pays for them to the time it’s customers pay for the corresponding finished goods

Working Capital


Working capital1

= it Matters” interesting.



Working Capital

What our suppliers finance for us

What we finance for our customers


Working capital ar
Working Capital: AR it Matters” interesting.

  • Typically most meaningful when expressed in terms of time

  • Days Sales Outstanding

  • Example: Our Company

    • Receivables: $18.493 Million

    • Sales: $450 Million or about $1.233 million/day

    • DSO: 15 days


Working capital ap
Working Capital: AP it Matters” interesting.

  • Days Payables Outstanding

  • Example: Our Company

    • Accounts Payable: $24.733 Million

    • COGS: $301.4 million plus transportation or about $826 thousand/day + avg daily transportation

    • DPO: 30 days (ignoring transportation)


Working capital inventory
Working Capital: Inventory it Matters” interesting.

  • Days in Inventory

  • We will have to do some work to estimate Inventory

  • Normally this would be an accounting process: How much inventory do we have?

  • We will estimate inventory. Why?


Cash to cash cycle

Days Sales Outstanding: 15 days it Matters” interesting.

Days in Inventory: + ? days

Days Payables Outstanding:30 days

Cash-to-Cash Cycle: ? days

Our Company: Net net, our suppliers fund 15 days of operations. Depending on inventories, we must fund the rest.

Cash-to-Cash Cycle


Dell s cash to cash cycle
Dell’s Cash-to-Cash Cycle it Matters” interesting.

That’s about $4.7 billion

Dell’s suppliers finance a month + of Dell’s operations



SC can influence DSO by providing perfect order delivery, prompt accurate billing, etc, integrating with customer accounting systems, …

SC can influence DSO and DPO by negotiating terms of sale, e.g., when title transfers, mode of delivery, etc.

We will mainly focus on Inventory. How can SC influence Inventory?



Fixed asset utilization

Utilization of Capital Equipment prompt accurate billing, etc, integrating with customer accounting systems, …

Sometimes at the expense of working capital – See “The Goal”

Recent story: Intel SC Transformation

Fixed Asset Utilization

Not required




Inventory is an INVESTMENT, not an expense prompt accurate billing, etc, integrating with customer accounting systems, …

Can speak of inventory in terms of




The latter are more common except when dealing with very specific operational details



Apples oranges

How to balance inventory INVESTMENT against operating EXPENSES?

Should I INVEST more in a hybrid to reduce my weekly fuel EXPENSES?

Can’t compare the difference in weekly or annual operating expenses with the difference in the investment!

Associate an operating EXPENSE with the INVESTMENT

Apples & Oranges


Inventory carrying cost

Usually expressed as a % of the value (at COGS) EXPENSES?

Many companies don’t have a good handle on this.

Two components

“Average Cost of Capital”

Operational Expenses associated with Inventory

Inventory Carrying Cost


Average cost of capital

Sources of Capital EXPENSES?

Shareholders – Equity

Bond holders and Creditors – Debt


Which gets a higher return?


Average Cost of Capital


Average cost of capital1

% of Equity * Cost of Equity, EXPENSES?

+% of Debt * Cost of Debt (1-Tax Rate)

Example: Our Company

From the Balance sheet

Total Assets: 287 million (ignoring inv.)

 NIBCLs: 25 million

262 million

Long Term Debt $130 million at 5%

Short Term Debt 0 million at 5.5%

Equity $132 million at Cost of Equity?

Average Cost of Capital


Average cost of capital2

% of Equity * Cost of Equity, EXPENSES?

+% of Debt * Cost of Debt (1-Tax Rate)

Example: Our Company

Debt 50% Cost of Debt 5%(1-24.9%)

Equity is 50% Cost of Equity 9%

Average Cost of Capital 6.39%

This will change when we include inventory in our capital and financing for inventory in our liabilities

Don’t worry about its changing.

Average Cost of Capital


Cost of inventory

Non-Capital Charges as % of Inventory EXPENSES?



Price Erosion: LCD TV prices fall 24%/year



Insurance & Taxes


Does this depend on the SKU?

Typical charge is ~10%

These are PRE-TAX costs

Capital charge was AFTER TAX

Cost of Inventory


Total cost of carrying inventory

Total (Pre-Tax) Cost of Carrying Inventory EXPENSES?

Non-Capital Charge (e.g., 10%)

Capital Charge/(1-Tax Rate)

Our Company

Non-Capital Charge (we will guess 10%) 10%

Capital Charge 6.39%/(1-24.9%) ~8.5%

Total Cost of Carrying Inventory 18.5%

What does this mean?

For every $100 million in inventory we carry

The annual cost of carrying that inventory is

~$18.5 million

We can compare THAT with annual operating expenses

Total Cost of Carrying Inventory

Let’s be careful to distinguish. Shout if you’re confused!



Income Statement focus on Profitability EXPENSES?

Usually think of increasing revenues or reducing expenses

Balance Sheet focus on Capital Utilization

Usually think of reducing working capital

Inventory Carrying Cost

Allows us to balance the two approaches

No one writes a check for Inventory Carrying Cost



Questions? EXPENSES?


Next step

Estimate Inventory EXPENSES?

Depends on how we operate

Today we

Minimize transportation costs by running full truckload direct (lowest rate and shortest distance)

Maximizes Gross Margin

What’s the effect on inventories?

How well are we balancing our competing metrics of financial performance?

Next Step


Types of inventory

Pipeline Inventory: Goods in transit EXPENSES?

Cycle Stock: Goods accumulating or depleting from batch operations, e.g., accumulating or selling off a truckload quantity

Safety Stock: Goods held as a buffer against variability in demand and in replenishment

Anticipation Stock: Accumulated because of limited capacity

Types Of Inventory


Cycle stock

Example: Accumulated at a shipping dock awaiting full truckload

Typically assume constant (long run average) rate of production

Cycle Stock


Cycle stock1
Cycle Stock truckload

Truck Load


Average Inventory? (Units or Value)

Average Inventory? (Days)



Cycle stock2

Inventory truckload

Cycle Stock

Truck Load

Average Inventory? (Units or Value)

Average Inventory? (Days)



Cycle stock3

Units: Half the size of the batch truckload

Value: Half the value of the batch

Time: Half the time to accumulate the batch.


We will see modifications of this simple model.

Cycle Stock


Pipeline inventory

Little’s Law truckload

L = l W

Number of items in the system (L) =

Rate the items arrive (l) *

Time each item spends in the system (W)

It doesn’t matter how they arrive

One at a time

In parcels

In truck loads

Pipeline Inventory


Pipeline inventory1

L, the items or value in the system truckload

l, the long run average rate at which items or value arrive (e.g., are shipped)

W, how long (in consistent units) they stay in the system (e.g., the transit time)

Example: Wal*Mart ships 60%¹ (by value) of all it sells from Asia to the US on container ships taking 15¹ days

COGs for 2010: $305 billion

What’s the pipeline inventory (value)

¹ Guesses

Pipeline Inventory


Pipeline inventory2

l, truckloadthe long run average rate at which items or value arrive (e.g., are shipped)

60% * $315 billion = $189 billion

$189 billion/365 = $517 million/day

W, how long (in consistent units) they stay in the system (e.g., the transit time)

15 days

L = lW = $517 million/day* 15 days

= $7.767 billion

Pipeline Inventory


Pipeline inventory3

That’s a $7.767 billion INVESTMENT truckload

It is always there floating on the water

Sometimes more, sometimes less

$7.767 billion on average

That’s the revenues of the 330th largest company in the Fortune 500

Eg. Eastman Chemicals, Dillards, Yahoo

Pipeline Inventory


Questions truckload


Challenge 1

In your groups, complete the financial statements for Our Company under current operating practices

Transportation costs


30,000 lbs per truck load*

Truck travels 500 miles per day

Inventory Costs

* We assume weight, not cube, floor space or maximum value determines the capacity of the vehicle.

Challenge 1



Completed Financial Statements Company under current operating practices

Brief presentation outlining your calculations

As VP of SC, what initiatives would you propose?

We will be building on this example. Organize and keep your work.

Avoid using values (e.g., Inventory carrying cost, truck load capacity, …) in formulas. Reference them so you can change them easily later

Due: Tuesday, Aug. 30

I will call on 1 or 2 teams to present in class




Questions? Company under current operating practices

Time to get to know each other for teams

I’ll end a bit early today. Hang around

Use Challenge 1 as a trial – Are these the people I want to work with?

What OR skills will we need?

We will do a small amount of Linear/MIP modeling

It is unlikely that the projects will require it (except possibly Audi)

Pretty basic probability and statistics


Thanks! Please continue.

T-Square forum

Next week:

Team presentations on Challenge 1

Begin to explore strategies for balancing operating expenses (e.g., transportation) and working capital (e.g, inventory)