ISTANBUL TECHNICAL UNIVERSITY – TURKISH AIRLINESISTANBUL TECHNICAL UNIVERSITY – TURKISH AIRLINES

Operations & Logistics Management in Air TransportationOperations & Logistics Management in Air Transportation

Dr. David Gillen (University of British Columbia)Dr. David Gillen (University of British Columbia)

&&

Dr. Benny Mantin (University of Waterloo)Dr. Benny Mantin (University of Waterloo)

June 9-14, 2014June 9-14, 20141

Logistics

Learning Objectives– Key components of logistics

• Order Processing, Inventory, Transportation, Sourcing, Warehousing, Materials Handling, and Packaging, integrated through a network of facilities (warehouses and distribution centers)

– Logistics is integral to a firm’s strategy

– Keys to managing logistics costs• Inventory management

• Transportation management

– Supply Chain Flexibility and Synchronization

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What is logistics?

• Logistics is the design and administration of systems to control movement and spatial positioning of factor inputs (raw materials, labor, capital, energy) work-in-process, and finished inventories at the lowest total cost.

• Our focus will be on inventory management and transportation management

The five functions of logistical work are interrelated

What do we know about Turkey

• 81 provinces

• Bordering countries: Armenia, Azerbaijan, Bulgaria, Georgia, Greece, Iran, Iraq, Syria

• Population (January 2013) 74.6 million (18th largest in the world)

• Urbanization: about 72 %

• Age structure: 0–14 years (26.0%); 15–64 years: (67.9%); 65 and above (6.1%)

• Nominal GDP (2012) US$790.5b

• GDP per capita (US$ current prices) (2012) - US$10,595.2

• GDP Composition: Agriculture (9.1%); Industry (27.9%); Services (63.0%)

• Public debt: 40.4 % of GDP

• Labor force (2012): 26.5 million

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6

Geographic Strength

International Freight-Modal Split

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Growth in Logistics Activities

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Care in Comparing Logistics Costs

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Year Nominal GDP ($T)

Inventory Cost

Transportation Cost

Administrative Cost

Total Logistics

Cost

Logistics % of GDP

1980 2.80 220 214 17 451 16.1

1985 4.22 227 274 20 521 12.3

1990 5.80 283 351 25 659 11.4

1995 7.40 302 441 30 773 10.4

2000 9.82 374 594 39 1007 10.3

2005 12.43 395 739 46 1180 9.5

2010 14.60 396 769 47 1212 8.3

U.S. logistics cost, 1980-2010 in five year intervals ($B)

The cost of logistics

Logistics Costs Canada-U.S. Comparison

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Logistics will continue its renaissance in the future

• Information technologies will automate many of the traditionally manual logistical functions:

– Automated port and rail operations

– RFID tagging of materials

– Advanced technologies for warehousing and inventory operations

• Removal of trade barriers will continue to expand global trade and logistics

• Outsourcing versus near-shoring– Implications for airlines?

• Logistical value proposition consists of a commitment to key customer expectations and requirements at a minimum cost

• The two elements of this value proposition are Service and Cost Minimization– Firms must make appropriate tradeoffs between service and cost

for each of their key customers

Logistical value proposition-Manufacturing & Service Industries

• Availability involves having inventory to consistently meet customer material or product requirements

• Operational performance deals with the time required to deliver a customer’s order– Key metrics for this area involve delivery speed and consistency

• Service reliability involves the quality attributes of logistics– Key to quality is accurate measurement of availability and operational

performance over time

Service benefits are created by logistical performance in 3 areas

Cost minimization using the total cost logistics model

• Focused on achieving the lowest possible cost for each individual function of logistics– For example, Transport the

material the cheapest way possible

• Expected lowest cost based on decisions that were cheapest for individual functions

• Ignored the impact of cost decisions across logistics functions

• Focused on achieving the lowest total cost across each function of logistics

• A cost decision in one function should consider impact to costs of all other logistics functions

– For example, Transporting material the cheapest way is slower than other choices. This requires an increase in storage cost to hold the material longer

– Would it still be a lower cost to use the cheapest mode of transport?

Traditional Cost Logistics Model Total Cost Logistics Model

Different perspectives on cost minimization

Minimize order processing cost+

Minimize inventory cost+

Minimize transportation cost+

Minimize warehousing, materials handling and packaging cost+

Minimize facility cost__________________________Lowest logistics cost

Minimize (order processing + inventory + transportation + warehousing, materials handling and packaging + facility) cost

_________________________ Lowest total logistics cost

Traditional Cost Logistics Model Total Cost Logistics Model

Framework: Total Logistics Cost Function

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Components of TLC

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TLC (Q, r: T, ST) = RDi + (UCTDi/365) + (SDi/Q) + (QCI/2) + rIC + K(Di/Q) N(Z)S1

where:TLC = total logistics costR = Transportation Rate per Unit between Origin and DestinationD = Annual Demand for some good ‘i’U = Carrying Cost of In-transit InventoryC = Value per UnitT = Transit Time of Transportation AlternativeS = Fixed Ordering Cost per OrderQ = Order QuantityI = Carrying Cost of Warehoused Inventoryr = Safety StockK = Stockout Cost per UnitN(Z) = Unit Loss IntegralS1 = Standard Deviation of Demand During Transit TimeST = Standard Deviation of Demand During Lead Time

How these Costs are Distributed

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Cost Conflicts: Speed versus Service Reliability

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Cost oftransportationservice

Inventory cost(includesstorage andintransit

Total cost

Rail Truck Air

Co

st,

in d

olla

rs

Transportation service(greater speed and dependability)

Other Cost Conflicts/Tradeoffs

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Improved customer service0 100%

(a) Setting the customer service level

Co

st

Lost sales cost

Transportation,order processing,and inventorycosts

Total costs

Increasing number of stocking points0

(b) Determining the number of warehouses in a logisticssystem

Co

st

Transportation costs

Total costs

Inventorycosts

0

Revenue

Re

ven

ue

0

Average inventory level0

(c) Setting safety stock levels

Lost sales cost

Total costs

Inventorycarryingcosts

Co

st

0Product run length and product sequencing

altenatives

(d) Setting the sequence of production runs formultiple products

Production costs

Total costsC

ost

0

Inventorycarryng cost

• Transportation is the operational area that geographically moves and positions inventory

• There are three basic ways to satisfy transportation requirements– Operate a private fleet of equipment

– Contract with dedicated transport specialists

– Engage carriers that provide different transportation services as needed on a per shipment basis

Transportation

Measuring CostsCost Structure

• Costs vary with factor prices, productivity & output

• Scale economies

• Scope economies

• Utilization economies

• Density economies

• Agglomeration economies

• Value of time/reliability

Accounting Costs

• Variable costs– Material

– Manufacturing/production

– shipping

• Fixed costs– Contracts

– Capital

– Manufacturing/production

• Ownership– Purchase

– Acquisition

– Usage

– salvage

• Opportunity cost-forgone sales25

Pricing

• Concept to ‘Willingness to Pay’

• Unit cost or average cost pricing

• Cost plus pricing

• Incremental cost pricing

• Differential Pricing (special case of Ramsey pricing)

• Non-linear pricing and two-part tariffs

• Bundling and unbundling

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The scope of integrated logistical operations

Responsiveness Variance reduction Inventory reduction Shipment consolidation Quality Life cycle support

Logistical integration requires achieving six objectives simultaneously

• The customer-specified delivery facility might be near a point of equal logistics cost or equal delivery time from two different logistics facilities

• The size of a customer’s order creates improved logistical efficiency if serviced through an alternative channel arrangement

• Decision to use a selective inventory stocking strategy

• Agreements between firms to move selected shipments outside the established echeloned or direct arrangements

• Co-opatition (Cooperation & Competition)

Example situations for flexible logistics structure

Supply chain synchronization• Supply chain

synchronization is the operational integration of multiple firms across a supply chain– Seeks to coordinate the flow

of materials, products and information between supply chain partners to reduce duplication of effort

– Seeks to reengineer internal operations of individual firms to leverage overall supply chain capability

• The performance cycle represents elements of work necessary to complete the logistics related to customer accommodation, manufacturing or procurement

• A performance cycle consists of the following elements– Nodes

– Links

– Inventory

• Base stock

• Safety stock

– Input and output requirements

The logistics performance cycle is the basic unit of supply chain design and operational control

• Major objective of logistics in all areas is to reduce performance cycle uncertainty

• Operational variance is randomly introduced during the cycle through– The structure of the performance cycle itself

– Operating conditions

– The quality of logistical operations

Performance cycle uncertainty

Total time to complete the customer delivery cycle is based on each task within the cycle

Figure 2.8 Performance Cycle Uncertainty

Inventory managementthe Economic Order quantity model

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Knowing what you've got,

Knowing what you need,

Knowing what you can live without –

That’s inventory control.

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Frank Wheeler, Revolutionary

Inventory• Definition: The stock of any item or resource used in an

organization

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Work-In-Process

Raw Materials & Component Parts

Finished Products

Replacement parts, tools & supplies

Goods in transit to warehouses or

customers

Importance of Inventory:2005 Fiscal Year

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Wall Mart(Billion $)

Boeing(Billion $)

General Motors

(Billion $)

Dell(Billion $)

Cash & Short-Term Investments

6.4 5.9 50.4 9.0

Account Receivable

2.6 5.2 180.7 5.4

Inventories 32.2 73.5% 7.7 35% 30.1 9.6% 0.57 3.3%

Other Current Assets

2.5 2.8 51.7 2.6

Total Current Assets

43.8 100% 22 100% 312.9 100% 17.7 100%

Other Assets 94.3 38.1 163.1 5.4

Total Assets 138.2 60 476.1 34.1

Importance of Inventory Management

• ... by 1990 Wal-Mart was already winning an important technological war that other discounters did not seem to know was on. “Wal-Mart has the most advanced inventory technology in the business and they have invested billions in it”. (New York Times, Nov. 95)

• Kmart increased its inventories to $8.3 billions in the third quarter of 2001 with an expectation of more shoppers. “But higher sales never materialized, leading to a disastrous holiday selling season.” Kmart filed for bankruptcy on Jan. 22. (Business Week, Mar. 02)

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Importance of Inventory ManagementMore Recent News

• SanDisk suspends production as inventories pile up for makers of computers, cell phones, and TVs … (Business Week, Dec. 08)

• Natural-gas futures soared 15% Thursday after U.S. inventory data slightly eased concerns about the possibility of a storage glut (Wall Street Journal, Sept. 11, 09)

• Fruit growers were blessed with excellent weather this year. But that hasn’t translated into a great year for the province’s cherry and blueberry growers, as a bumper crop has flooded the market and pushed down prices. (The Vancouver Sun, Aug. 09)

• The Ford assembly plant in Oakville and 3,000 workers will remain idle this week because of a parts shortage from a supplier in India. (Toronto Star, Oct. 27, 09)

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Why do you have these inventories?

Why do you have these inventories?

What are some of the inventories that you have?

What are some of the inventories that you have?

Why should you hold inventory?

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Predictable VariabilityPredictable Variability Seasonal Inventories

Unpredictable VariabilityUnpredictable Variability Safety Stock

Economies of ScaleEconomies of Scale Cycle Stock

Transportation times / Flow times

Transportation times / Flow times

Pipeline Inventories

Other: Strategic / Speculative / etc.Other: Strategic / Speculative / etc.

Why should you not hold inventory?

• Inventory increases certain costs such as– Carrying cost

– Cost of customer responsiveness

– Cost of diluted return on investment

– Large-lot quality cost

– Cost of production problems, etc.

• The Sea of InventoryInventory hides problems …

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Reducing waste: The Sea of Inventory

How much inventory should you hold?• Trade-off #1

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• Trade-off #2

Inventory Costs

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Inventory Classification

45(The above percentages are approximate)

A classification to help manage inventories better

Motivation: ATM

• How much cash do you take out from ATM?

• Why not more or less?

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Economic Order Quantity (EOQ)• The Economic Order Quantity (EOQ) balances

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• Assumptions– Known annual demand, constant demand rate– No uncertainty

Notation

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D Annual Demand Rate

Q Lot or batch size

S Set-up cost per lot/batch, or average cost of processing/placing an order

C Unit cost

H Annual holding and storage cost per unit of average inventory

i Percent carrying cost (e.g., “interest” rate)

Usually, H = iC.

Cycle Stocks: Tradeoff between fixed costs and holding costs

Profile of Inventory Level over Time

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Quantityon hand

Q

Receive order

Receive order

Receive order

Demand rate

Time

Example: “The South Face”• Some facts about The South Face retail shop

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• What order size (Q) would you recommend for The South Face?

D Annual Demand Rate 1200 jackets/year

S Set-up cost per lot/batch, or average cost of processing/placing an order

$2,000

C Unit cost $200 per jacket

i Percent carrying cost (e.g., interest rate)

25%

Thus, H = iC = (0.25)*($200) = $50 per unit-year

The South Face

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Q

Time t

Inventory Profile:# of jackets in inventory over time.

D = Demand rate

Inventory

D Annual Demand

Q Lot or batch size (Number of jackets per replenishment order)

Number of orders per year D/Q

Average inventory Q/2

Annual Setup Cost (D/Q) * S

Annual Holding Cost (Q/2) * H

Annual Total Cost Annual Setup Cost + Holding Cost

S Order or setup cost

H Annual Holding cost

???

???

Q/2Q/2

The South Face: Cost

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Per Order/BatchQ

Batches per YearD/Q

AnnualSetup Cost

Annual Holding Cost

AnnualTotal Cost

50 24.0 48000 1250 49250

100 12.0 24000 2500 26500

150 8.0 16000 3750 19750

200 6.0 12000 5000 17000

250 4.8 9600 6250 15850

260 4.6 9231 6500 15731

270 4.4 8889 6750 15639

280 4.3 8571 7000 15571

290 4.1 8276 7250 15526

300 4.0 8000 7500 15500

310 3.9 7742 7750 15492

320 3.8 7500 8000 15500

330 3.6 7273 8250 15523

340 3.5 7059 8500 15559

350 3.4 6857 8750 15607

400 3.0 6000 10000 16000

500 2.4 4800 12500 17300

600 2.0 4000 15000 19000

700 1.7 3429 17500 20929

Cost Minimization Goal

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SQ

DH

QTC

2

Ordering Costs SQ

D

Inventory holding cost

HQ

2

Order Quantity (Q)

Annual Cost

QO (optimal order quantity)

Lowest Annual

Cost

Total Cost

Economic Order Quantity

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SQ

DH

QQTC

2)(TotalCost

D Annual Demand Rate

S Order or Setup Cost

H Annual Holding Cost

H

SDQOPT

2

Economic Order Quantity:The South Face

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D 1200 jackets/year

S $2,000

H $50 per unit-yearH

SDQOPT

2

• What is the optimal order quantity?

• How many times would you place orders per year, i.e., frequency of ordering?

• What is the time duration between successive orders (this is also called the cycle time or reorder interval)?

8.30950

)1200)(2000(22

H

SDQOPT

8.38.309

1200

OPTQ

D

258.01200

8.309

D

QOPT

EOQ and Sensitivity Analysis

• What happens to the cost and optimal quantity as the parameters change?

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H

SDQOPT

2

As …. “Cost” EOQ Frequency

S ↑ ↑ ↑ ↓

H↑ ↑ ↓ ↑

D↑ ↑ ↑ ↑

Managerial Implications of EOQ

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• Cost curve is almost “flat” near the optimal point– Use the EOQ formula, but do not worry about making minor

adjustment to get a number that is “more realistic” for your organization

• The flatness of the cost curve implies that the EOQ figure is “robust”– Estimating holding cost is usually difficult

– The EOQ formula guarantees that the “optimal” order quantity is not very sensitive to errors in estimation

Managerial ChallengesHow to estimate costs?

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Managerial ChallengesHow to reduce the EOQ inventory?

• Reduce the set-up cost

• Re-evaluate sources of fixed costs, and find ways to reduce, spread-out, or eliminate these costs

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H

SDQOPT

2

Appendix material

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ContentsI. INTEGRATED LOGISTICS MANAGEMENT

Ia. The Growth of Logistics and Its Role in the EconomyA. What is Logistics?B. History of LogisticsC. Role of Logistics in the EconomyD. Why Logistics is gaining in importance

Ib. The Integrated Logistics Management ConceptA. DefinitionB. Logistics is concerned with questions about inventoriesD. Strategic profit analysis

Ic. Logistics As An Element of Corporate StrategyA. A Few Logistics FactsB. Corporate Leverage From LogisiticsC. Product Strategy: Innovation PhaseD. Product Strategy: Cost Leadership PhaseE. Product Line (Customer Service) Strategies

ContentsId. Distribution Channels

A. Channels: Definition, Types, FunctionsB. Integrated Channel ConceptC. Some Logistical Implications

Ie. Customer ServiceA. Defining Customer ServiceB. Measuring Customer ServiceC. Relationship of Customer Service to MarketingD. Optimizing Customer ServiceE. StockoutsF. Stockout CostsG. ABC Analysis

If. International LogisticsA. Importance of International LogisticsB. International StrategiesC. Some Additional Considerations

ContentsII. LOGISTICS SYSTEM ELEMENTS

IIa. Inventory Management ‑ IntroductionA. Financial ImpactB. Reasons for Holding InventoryC. Types of InventoryD. Example of Financial ImpactIIb. Inventory ‑ Carrying CostsA. GeneralB. Capital CostsC. Other CostsD. Annual Inventory CostsE. Valuing Inventory (i.e. Value on Balance Sheet)F. Why Inventory Costs are Often MisstatedIIc. Inventory ‑ Management Under Certainty (EOQ)A. Basic Inventory CycleB. Ordering CostsC. Effect of Decrease in Cycle TimeD. Total CostsE. Optimum Quantity to OrderF. Quantity DiscountsG. Other Cases

ContentsIId. Inventory ‑ Uncertainty

A. Calculating Safety StocksB. Example of Safety Stock CalculationsC. The Flip Side: Reducing Cycle Variability for Your CustomersD. Appendix Derivation of Formula for σc

IIe. Inventory ‑ ControlA. Stock Control MethodsB. Inventory System DesignC. Fixed Order PointD. Fixed Order IntervalE. Transport Choice CaseF.Items covered in readings, not in lecturesG.Postscript: Inventory, Production, Marketing, Finance

IIf. International ShippingA. ImportanceB.TechnologyC.Demand - Shippers (Two main market segments)D.Supply - Shipping Carriers/OwnersE.Freight Rates

ContentsIIg. Transport ‑ Modes and Service Characteristics

A. Mode CharacteristicsB. CostsC. Rate-Service Tradeoff

IIh. Transportation: ConsolidationA. Types of ConsolidatorsB. Reasons for ConsolidationC. Types of ConsolidationD. Typical LTL RoutingE. Containers

IIi. Transportation: Traffic ManagementA. Traffic Management FunctionsB. DeregulationC. NegotiationsD. Private Versus Public Carriage

ContentsIIj. Warehousing

A. Functions of WarehousingB. Types of WarehousesC. Optimal Number of WarehousesD. Optimal Size of WarehouseE. Stock Location MethodsF. Order Picking DesignG. Public versus Private Warehouse ChoiceH. A Note on Warehouse Costs

IIk. Facility LocationA. Two Types of Locational DecisionsB. Transport Cost ModelsC. Other Locational DecisionsD. Tactical Location Considerations

ContentsIIl. Packaging

A. The Two Functions of PackagingB. UnitizationC. Packaging MaterialsD. Some Packaging Problems/SolutionsE. Where/When Should Packaging Be Added?

IIm. PurchasingA. IntroductionB. Forward BuyingC. Other Aspects of Purchasing

IIn. Materials ManagementA. IntroductionB. Materials Requirement Planning (MRP)C. Manufacturing Resource Planning (MRP II)

ContentsIIo. Total Quality Management

A. IntroductionB. TQM versus Traditional ApproachC. Employee motivationD. Examples

IIp. Just-in-Time SystemsA. Just-In-Time-SystemB. Manufacturing Resource Productivity (MRP III)

IIq. Production SystemsIIr. Distribution Requirements Planning

A. Distribution Requirements Planning (DRP)IIs. Order Processing

A. The Order CycleB. The Order Processing SystemC. Impact on LogisticsD. Implications of Advanced Order Processing Systems

Inventory Turns 2007 Canada

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