Total Cost Integration
Economic forces such as transportation and inventory determine a firm's
most appro-priate network of warehouse facilities. This discussion
identifies cost trade-offs related to transportation and inventory followed
by integration to identify the least total cost facility network.
Transportation Economics
The key to achieving economical transportation is summarized in two
basic principles. The first, often called the quantity principle, is that
individual shipments should be as
, Clitrr~~er15
Network Inlegrcl~io~i
455
large as the involved carrier can legally transport in the equipment being
used. The second, often called the tapering principle, is that large
shipments should be trans-ported distances as long as possible. Both of
these principles serve to spread the fixed cost related to transportation
over as many pounds and as many miles as possible. Economies of
transportation consolidation may justify establishment of a single ware-
house or may be achieved across a network of warehouses.
Cost-Based Warehouse Justification
The basic economic principle justifying establishment of a warehouse is
transportation consolidation. Manufacturers typically sell products over
a broad geographical market area. If customer orders tend to be small,
then the potential cost savings of consoli-dated transportation may
provide economic justification for establishing a warehouse.
To illustrate, assume a manufacturer's average shipment size is 500
pounds and the applicable freight rate to a customer is $7.28 per
hundredweight. Each shipment made direct from the manufacturing
location to the market would have a transporta-tion cost of $36.40. The
quantity or volume transportation rate for shipments 20,000 pounds or
greater is $2.40 per hundredweight. Finally, local delivery within the
market area is $1.35 per hundredweight. Under these conditions,
products shipped to the mar-ket via quantity rates and distributed locally
would cost $3.75 per hundredweight, or $18.75 per 500-pound
shipment. If a warehouse could be established, stocked with in-ventory,
and operated for a total cost of less than $17.65 per 500-pound shipment
($36.40 - $18.75) or $3.53 per hundredweight, the overall cost of
distributing to the market using a warehouse would be lower. Given
these economic relationships, estab-lishment of a warehouse offers the
potential to reduce total logistics cost.
Figure 15-1 illustrates the basic economic principle of warehouse
justification. PL is identified as the manufacturing location, and WL is
the warehouse location within a given market area. The vertical line at
point PL labeled PC reflects the handling and shipping cost associated
with preparation of a 500-pound LTL shipment (C) and a 20,000-pound
truckload shipment (A). The slope of line AB reflects the truckload
freight rate from the plant to WL, the warehouse, which is assumed for
this example to be linear with distance. The vertical line labeled WC at
point WL represents the cost of
Economic justification
,of a warehouse facility
based on transportation
cost
PL Ma WL Ma'
, Pcrrt IV Network L)esigrl
operating the warehouse and maintaining inventory. The lines labeled D
reflect deliv-ery cost from the warehouse to customers within the
market area Ma to Ma'. The slope of line CD reflects the LTL rate from
the plant to customers located between the plant and the boundary Ma'.
The shaded area represents the locations to which the total cost of a
500-pound customer shipment using a consolidation warehouse would
be lower than direct shipment from the manufacturing plant.
From the perspective of cost alone, it would make no difference
whether cus-tomers located exactly at points Ma and Ma' were serviced
from the manufacturing plant or the warehouse.
Network Transportation Cost Minimization
As a general rule, warehouses would be added to the network in
situations where
where Pv = Processing cost of volume shipment;
Tv = Transportation cost of volume shipment;
Wi; = Warehousing cost of average shipment;
Lit = Local delivery of average shipment;
N;; = Number of average shipments per volume
shipment; Pi; = Processing cost of average
shipment; and Tic= Direct freight cost of
average shipment.
The only limitation to this generalization is that sufficient shipment
volume be avail-able to cover the fixed cost of each warehouse facility.
As long as the combined cost of warehousing and local delivery is equal
to or less than the combined cost of ship-ping direct to customers, the
establishment and operation of additional warehouse fa-cilities would
be economically justified.
The generalized relationship of transportation cost and number of
warehouses in a network is illustrated in Figure 15-2. Total
transportation cost will initially decline as warehouses are added to the
logistical network. In actual operations, a consolidation
FIGURE15-2
Transportation cost as a
function of the number
of warehouse locations
Economic forces such as transportation and inventory determine a firm's
most appro-priate network of warehouse facilities. This discussion
identifies cost trade-offs related to transportation and inventory followed
by integration to identify the least total cost facility network.
Transportation Economics
The key to achieving economical transportation is summarized in two
basic principles. The first, often called the quantity principle, is that
individual shipments should be as
, Clitrr~~er15
Network Inlegrcl~io~i
455
large as the involved carrier can legally transport in the equipment being
used. The second, often called the tapering principle, is that large
shipments should be trans-ported distances as long as possible. Both of
these principles serve to spread the fixed cost related to transportation
over as many pounds and as many miles as possible. Economies of
transportation consolidation may justify establishment of a single ware-
house or may be achieved across a network of warehouses.
Cost-Based Warehouse Justification
The basic economic principle justifying establishment of a warehouse is
transportation consolidation. Manufacturers typically sell products over
a broad geographical market area. If customer orders tend to be small,
then the potential cost savings of consoli-dated transportation may
provide economic justification for establishing a warehouse.
To illustrate, assume a manufacturer's average shipment size is 500
pounds and the applicable freight rate to a customer is $7.28 per
hundredweight. Each shipment made direct from the manufacturing
location to the market would have a transporta-tion cost of $36.40. The
quantity or volume transportation rate for shipments 20,000 pounds or
greater is $2.40 per hundredweight. Finally, local delivery within the
market area is $1.35 per hundredweight. Under these conditions,
products shipped to the mar-ket via quantity rates and distributed locally
would cost $3.75 per hundredweight, or $18.75 per 500-pound
shipment. If a warehouse could be established, stocked with in-ventory,
and operated for a total cost of less than $17.65 per 500-pound shipment
($36.40 - $18.75) or $3.53 per hundredweight, the overall cost of
distributing to the market using a warehouse would be lower. Given
these economic relationships, estab-lishment of a warehouse offers the
potential to reduce total logistics cost.
Figure 15-1 illustrates the basic economic principle of warehouse
justification. PL is identified as the manufacturing location, and WL is
the warehouse location within a given market area. The vertical line at
point PL labeled PC reflects the handling and shipping cost associated
with preparation of a 500-pound LTL shipment (C) and a 20,000-pound
truckload shipment (A). The slope of line AB reflects the truckload
freight rate from the plant to WL, the warehouse, which is assumed for
this example to be linear with distance. The vertical line labeled WC at
point WL represents the cost of
Economic justification
,of a warehouse facility
based on transportation
cost
PL Ma WL Ma'
, Pcrrt IV Network L)esigrl
operating the warehouse and maintaining inventory. The lines labeled D
reflect deliv-ery cost from the warehouse to customers within the
market area Ma to Ma'. The slope of line CD reflects the LTL rate from
the plant to customers located between the plant and the boundary Ma'.
The shaded area represents the locations to which the total cost of a
500-pound customer shipment using a consolidation warehouse would
be lower than direct shipment from the manufacturing plant.
From the perspective of cost alone, it would make no difference
whether cus-tomers located exactly at points Ma and Ma' were serviced
from the manufacturing plant or the warehouse.
Network Transportation Cost Minimization
As a general rule, warehouses would be added to the network in
situations where
where Pv = Processing cost of volume shipment;
Tv = Transportation cost of volume shipment;
Wi; = Warehousing cost of average shipment;
Lit = Local delivery of average shipment;
N;; = Number of average shipments per volume
shipment; Pi; = Processing cost of average
shipment; and Tic= Direct freight cost of
average shipment.
The only limitation to this generalization is that sufficient shipment
volume be avail-able to cover the fixed cost of each warehouse facility.
As long as the combined cost of warehousing and local delivery is equal
to or less than the combined cost of ship-ping direct to customers, the
establishment and operation of additional warehouse fa-cilities would
be economically justified.
The generalized relationship of transportation cost and number of
warehouses in a network is illustrated in Figure 15-2. Total
transportation cost will initially decline as warehouses are added to the
logistical network. In actual operations, a consolidation
FIGURE15-2
Transportation cost as a
function of the number
of warehouse locations
