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Developing a framework for


evaluating the logistics costs in
global sourcing processes

Evaluating the
logistics costs

785

An implementation and insights


Amy Z. Zeng
Department of Management, Worcester Polytechnic Institute, Worcester,
Massachusetts, USA, and

Christian Rossetti
Department of Supply Chain Management, College of Business,
Arizona State University, Tempe, Arizona, USA
Keywords Sourcing, Transportation, Logistics, Performance measures, Case studies
Abstract Global sourcing is becoming a prerequisite for companies competing in todays market.
The logistics costs often comprise a large portion of the total global sourcing cost, thereby
determining the effectiveness of this procurement strategy. However, evaluating the logistics cost in
a global context is frequently difficult. This paper presents a five-step evaluation framework and
illustrates how this framework can be implemented using a case study at a leading firm in the US
aviation industry and its part supplier in Chengdu, China. The framework not only identifies the
key logistics cost items, but also suggests a way of quantifying each of the cost elements. The
computational part of the framework can be easily implemented on spreadsheets and offers
substantial flexibility to accommodate assessment of various transportation alternatives and
sensitivity analysis.

1. Introduction
Improved technology and intensified competition have enabled and forced
companies to expand their markets worldwide. The most successful companies
often develop their products in Europe and the USA, manufacture in Asia and
Latin America, and sell worldwide (Burnson, 1999). As one of the consequences
of this trend, global sourcing has rapidly arisen as a prerequisite for companies
competing in todays market. Defined by Monczka and Trent (1991), global
sourcing is the integration and coordination of procurement requirements
across worldwide business units, looking at common items, processes,
technologies, and suppliers. This procurement strategy has extended
organizations supply chains to a global scale.
The authors would like to thank APICS the E&R Foundation and Supply Chain Council for
their financial support for this project (Grant #2000-3) and the inputs and participation of the two
companies. The authors would also like to extend their gratitude to the reviewers for their
thoughtful and constructive comments, which have helped improve the quality of this paper.

International Journal of Physical


Distribution & Logistics Management
Vol. 33 No. 9, 2003
pp. 785-803
q MCB UP Limited
0960-0035
DOI 10.1108/09600030310503334

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Logistics processes form the critical loops of supply chains and oversee the
flows of materials, information and cash, which are the essential elements of
fulfilling customers orders. As greater distances, currencies and cultures
separate markets, suppliers and manufacturers, logistics plays a more critical
role in the success of the supply chains. As a result, total logistics cost has
become one of the most important economic indicators of supply chain
efficiency. Gilmore (2002) explicitly points out that there is a growing
recognition of the role that transportation and logistics excellence plays in
achieving a world-class supply chain and that transportation costs represent a
substantial component of overall supply chain and corporate spend for many
companies.
The costs associated with logistics activities normally consist of the
following
components:
transportation,
warehousing,
order
processing/customer service, administration, and inventory holding (e.g.
Lambert et al., 1998; Saccomano, 1999). Not surprisingly, total logistics costs
often represent a large portion of total supply chain costs, especially when the
supply chain is extended to the global market. For example, previous studies
have found that logistics costs have ranged from 4 to over 30 percent of sales
(Ballou, 1999). As more organizations are outsourcing their products or services
to global suppliers, it becomes increasingly critical to understand and evaluate
the various logistics cost components in order to assure the profit margin.
However, the existing methodologies for evaluating the total logistics cost,
especially of global supply chains, are sparse due in large part to the
complexity of a global logistics system and the variety of cost items involved.
This paper relies on the practices, experiences, and data of a leading firm in the
US aviation industry and one of its part suppliers in China to derive and
implement an evaluation framework for assessing the total logistics cost. As
requested by the companies, we will disguise their identities and refer to the
parent company in the USA as company P and its joint venture in China as JV
throughout the paper.
There are numerous items that define a successful outsourcing relationship.
The two companies must confront issues that include forecasting, differences
in internal operations, coordination of business activities, previous
partnerships, and relationships between the providers of raw materials,
freight forwarders and end customers. In addition, outsourcing to China
involves the increased difficulties associated with differences in culture,
language, poor inland transportation and antiquated customs procedures.
Recently many authors have attempted to provide a framework for a more
holistic view of outsourcing relationships; however, in this paper, we have
limited our focus to the cost-effectiveness of the companies global logistics
systems. Thus, the major objectives of this study are three-fold and explained
as follows. First, the major cost components of the global logistics systems are
identified and documented for analysis. Company P, a partial sponsor of this

research, requested that the cost components remain valid regardless of the
national origin of the outsourcing partner, therefore, these components retain a
generality that allows their transference to future research and case analyses.
Second, a framework for classifying and evaluating the logistics cost
components is presented. Finally, we demonstrate how this framework can be
implemented on spreadsheet using the data we have collected from the two
companies. Furthermore, we provide examples of sensitivity analysis to
illustrate the flexibility of this spreadsheet-based evaluation procedure and the
robustness of the framework.
This paper is organized in the following manner. In section 2, a brief
description of the background and history of these two companies is given.
Their business relationships and the characteristics of the global logistics
system are also provided. Section 3 contains a review of existing literature
related to logistics cost analysis. In section 4, the categories of the logistics cost
items resulting from the case study are presented, followed by a detailed
description of our five-step evaluation framework. In section 5 we discuss the
implementation of our evaluation procedure on the spreadsheet, sensitivity
analysis, and a summary of managerial implications. Finally, concluding
remarks including a discussion of the limitations of the newly developed
evaluation framework and future research direction are given in section 6.
2. The companies
2.1 Background
Company P is a leader in the design, manufacture and support of engines for
commercial, military and general aviation aircraft, and space propulsion
systems. The demand for company Ps products in todays competitive aviation
industry is thrust at the lowest possible cost with the highest level of reliability.
In a business that shrinks the globe, company P is truly worldwide, having
established partnerships and joint ventures that reach to Asia and Europe and
have kept the company at the forefront of flight.
Given the complexity and history of aircraft engine development, vertical
integration was traditionally the dominant form of business structure in the
aviation propulsion industry. However, potential market penetration, high cost
of development, and fierce competition from foreign suppliers have fueled the
desire of several large aircraft engine manufacturers in the USA to go global.
The competitive bidding procedure used in purchasing company Ps engines
by government owned airlines often requires company P to accept different
forms of payment or requirements not usually found in normal purchase
agreements. In our case study, as company P attempted to penetrate the
Chinese market in the early 1990s, the Chinese government asked for job
opportunities for Chinese workers and technology transfer for its own aviation
industry. Company P complied by forming a joint venture (JV) in Sichuan
Province in 1996. Company P supplied the initial capital investment and

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machinery for the project and continues to provide technical assistance and
tooling for the JV. The JV has since become the primary manufacturer of four
types of engine parts: burner cans, pin disks, shrouds, and shroud vane
assemblies.
Due to the high reliability necessary for safe air transportation, the raw
materials (such as metal sheets) for any engine parts and subassemblies
must satisfy the stringent standards set forth by the Federal Aviation
Association. The current certified suppliers of the raw materials are only
located in North America and Europe. In addition, not only is China unable
to provide these raw materials, but due to United States national security
laws, company P cannot help the JV develop internal sources. As a result of
this and the desire by company P to limit cash held by the JV, the two
companies have formed a vendor-required-material (VRM) relationship since
the first day of operation of the JV. In this VRM relationship, company P
purchases the raw materials from one of its licensed suppliers and sends the
materials through a preferred freight forwarder to the JV. It also holds the
financial responsibility for shipping the material to and from the JV and
paying the value-added service provided by the JV. Adding to this heavy
financial burden is the major transportation mode that is currently adopted
by company P: the raw materials as well as the finished engine parts are
primarily shipped by air between its headquarters and Chengdu, China, due
to various reasons. As company P outsources more parts to its joint venture
located in the Far East, it is increasingly concerned with the logistics costs
associated with moving raw materials and finished products. For this
reason, one of the major challenges confronted by company P is the proper
evaluation of the cost and profitability associated with the aircraft engine
parts outsourced in China and other countries.
2.2 Transportation and distribution
The JV is located in Chengdu, Sichuan province, China. Chengdu is an
inland city with population of 9.5 million and surrounded by mountains that
make land transportation difficult even under the best conditions. Because of
the disparity between global transportation and transportation within inland
China we have divided the logistics network into two major segments:
outside of China and within China. After careful consultation with the two
companies, several freight forwarders, and a series of long-haul drivers, we
present the backbone of the global sourcing process in the form of possible
transportation routes and modes as illustrated in Figure 1. This figure is
valid for inbound shipments of raw material and outbound shipments of
finished goods. Of mode possibilities, we see from Figure 1 that air can be
used entirely between the two companies and that, if water is chosen for
transport between company P and Shanghai, then either truck or rail can be
utilized to move materials between Shanghai and Chengdu. Note that

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logistics costs

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Figure 1.
The transportation
routes for the
material flow

Shanghai is a major port city in China and about 1,000 kilometers from
Chengdu. Therefore, three potential transportation modes, namely all air,
water-rail combination, and water-truck combination, are possible. In
addition, both full container load (F) and less-than container load (L) for
truck and rail should be examined. As a result, a total of five potential
transportation alternatives, namely water-rail full container load (WRF),
water-rail less-than container load (WRL), water-truck full container load
(WKF), water-truck less-than container load (WKL), and air, become
potential candidates for moving raw materials and finished goods.
3. Evaluating total logistics cost: literature review
The majority of prior research on logistics costs can be grouped into two
streams. One stream focuses on strategic aspects of the logistics costs, and the

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other deals with optimized cost-effective logistics decisions. There is a large


body of literature pertinent to the strategic role logistics plays in creating value
and its relationship to a companys financial performance. As reported by
Richardson (1995) and later stressed by Gilmore (2002), logistics controls a
significant amount of assets and has direct impact on cash flow and the bottom
line, adds value through continuous productivity and service improvements,
and possesses a strong relationship with a firms customer service level and
revenues. As global sourcing is rapidly arising as an important business
strategy, capturing and evaluating the logistics costs involved in the global
supply chain appears as increasingly critical and important as uncovering the
strategic benefits (Fagan, 1991). Numerous factors can drive up logistics costs
substantially, which may offset the benefits of doing business with the
international suppliers.
The techniques utilized to analyze the logistics cost can be summarized into
four categories: recurrence-based, regression-based, activity-based, and
optimization-based. For example, a previous study completed by Fera (1998)
attempts to identify and classify the relevant cost factors for evaluating the
feasibility of the international outsourcing strategy for company P. A
comprehensive list of recurring and non-recurring cost items accounting for
international sourcing is provided for future analysis. Zoroya (1998) presents a
regression model to measure the cost drivers of shippers transportation
expenses, where three time-based factors are used to examine what influences
the price of a transportation lane. The activity-based costing approach to
accounting for the logistics costs is presented by van Damme and van der Zon
(1999), which helps top management analyze the financial information in order
to make logistics decisions.
The other stream, using the optimization-based method, comprises a large
body of literature on analyzing the system logistics costs. This technique
normally attempts to optimize the total logistics cost including transportation
in conjunction with inventory and purchasing decisions. The earliest studies of
transportation and logistics costs arose from economic analyses relating to the
cost of perfect competition between firms competing in the same market but
producing in different locations. It was not until the early 1970s, however, with
the promotion of air movement that comprehensive comparisons of inter-modal
freight options, which considered the inventory holding cost associated with
transportation time, were presented. Table I provides an overview of a number
of topical areas that have been covered in existing studies. The
optimization-based method has significant limitations with respect to the
number of cost items, the effect of international trade, and the possibility of
finding the closed-form or easy solutions.
In this paper we extend the logistics cost categorization proposed by Maltz
and Ellram (1997) and present a new way to classify the cost items based on the
global logistics system of the two companies under investigation. The logistics

A multi-modal transport cost model is used to


Banomyong and Beresford (2001)
clarify routing alternatives
Direct and cross-elasticity estimates of the
Beuthe et al. (2001)
demands for three freight transportation modes:
rail, road and inland waterways
An optimization model incorporating various
Zeng (2002)
global logistics items is developed

Joint optimal decisions of purchasing, inventory Tyworth and Zeng (1998)


holding and transportation
Modeling the effects of uncertainties in global
Vidal and Goetschalckx (2000)
logistics systems

Tyagi and Das (1997)

Swenseth and Godfrey (1996)


Liao (1997)

Only transport and inventory costs are


considered
Five estimation methods are presented
The only international factors included in the
total cost model are those of duties and taxes
A mathematical programming model based on
analytic hierarchy process
Only one transportation mode is considered
There is no international factor
The sensitivity of key cost drivers such as
exchange rate and lead time on minimum total
cost is evaluated
A confidence index is introduced for each route,
transport modes and nodal links
Ten different categories of goods with a detailed
multi-modal network model of Belgian freight
transports are evaluated
Six categories of logistics cost items are
incorporated in the model and the only decision
variable is the shipping weight

Scharty and Larsen (1995)

Freight cost estimation in logistics decisions


Freight cost structure and the cost of locating
manufacturing facilities in a foreign country
Cost and service tradeoff

Total logistics cost is used as a criterion


An integrative approach is utilized

Slijper (1979)
Carter and Ferrin (1995)

Comparison of air freight with other modes


Incorporating transportation costs in supply
chain management decisions
Optimization of total cost

Remarks

Selected authors

Topics covered

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Table I.
Examples of
optimization-based
research on
logistics cost

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cost includes not only the classic cost components, but also items associated
with international transportation. After these cost items are identified, we
propose a framework for evaluating the effectiveness of various transportation
alternatives, and then demonstrate how this framework can be easily
accomplished by spreadsheets.
4. Proposed evaluation framework
4.1 Cost categories
The common concerns that many companies engaged in global sourcing have
may include the most cost-effective transportation mode and the total amount
spent on sourcing from foreign countries. It is generally agreed that
manufacturing cost is significantly lower in developing countries; however, the
extended distance, the coordination between the partners, and numerous other
problems related to international trade often complicate the profit picture. Here
we only address the logistical aspect of global sourcing. Currently, company P
does not have a well-developed procedure for analyzing the associated data, nor
has it established any centralized database to store and retrieve the
information. Based on the data we have collected, we classify the logistics
costs into six categories: transportation, inventory holding, administration,
customs charges, risk and damage, and handling and packaging. Each
category comprises a number of cost elements. The complete description of the
categories is reported in Table II.
4.2 The evaluation framework
Once the logistics cost items are identified, we propose an evaluation procedure
for assessing the costs associated with each available transportation
alternative. The complete procedure can be depicted in Figure 2. The five
steps involved in the procedure are explained as follows:
(1) Step 1. Identify the objective, which is to examine the logistics cost
associated with global sourcing. The results will not only aid decision
making in transportation mode selection, but also help the buying
organization understand the costs and benefits associated with global
sourcing.
(2) Step 2. Establish a set of possible modes and combination of modes
available for transporting raw materials and finished goods in and out of
the global manufacturer. As discussed before, for the companies under
study, five alternatives need to be evaluated and compared
simultaneously.
(3) Step 3. Develop the minimum number of input parameters required to
ascertain the costs associated with the previously mentioned six logistics
cost categories. For our study we were able to reduce the input
parameters used to describe the operations of the two companies to nine
variables, as listed below:

Logistics cost category


(1) Transportation

Brief definition
Freight charge
Consolidation
Transfer fee
Pickup and delivery

Cost incurred during delivery using


various transportation modes
The fee for combining small
shipments to form larger shipments
Cost incurred during the transfer of
goods between different modes of
transportation
Transportation charges incurred
between shippers warehouse and
air, rail consolidators terminal

(2) Inventory holding

Pipeline holding
Safety stock

Holding cost during the transfer


Holding cost of safety stock

(3) Administration

Order processing

Salaries of employees responsible for


purchasing and order management
Telephone, fax and information
transfer related costs associated with
international logistics
Rent paid by the international
logistics group

Communication
Overhead

(4) Customs

Customs clearance
Brokerage fee
Allocation fee

(5) Risk and damage

Damage/loss/delay
Insurance

(6) Handling and


packaging

Terminal handling
Material handling
In/out handling
Disposal charge
Packaging/supplies materials
Storage

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Fee imposed by local customs to


clear goods
Charge levied by an agent acting on
behalf of the shipper or the receiver
depending on the delivery terms
Per house-bill
Percentage of the value of each unit
shipped that will be lost, damaged or
delayed
Min $25 or $0.50 per $100.00 insured
value
Material handling fee charged by the
transportation company
Cost of labor and equipment used to
move goods within the shippers or
receivers warehouse
Material handling charge levied by
the freight forwarder for use of its
facilities
Fee for taking away an empty
container from the receivers
warehouse
Cost of preparing goods for shipment
Rental fee of the warehouse space

Table II.
Total logistics cost
elements

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Figure 2.
The evaluation
procedure of the total
logistics cost

.
.
.
.
.
.
.
.
.

raw material costs ($/unit);


finished product cost ($/unit);
holding cost percentage at the JV (%).
holding cost percentage at company P (%);
total yearly demand (units/year);
weight of raw material (kg/unit);
weight of finished part (kg/unit);
shipment frequency of raw materials per year; and
shipment frequency of finished products per year;

It should be pointed out that since the JV manufactures multiple engine


parts, aggregated values of the above parameters should be used for
calculation.
(4) Step 4. Re-classify the cost elements into three groups: weight-based,
value-based, and shipment frequency-based based on the dimensions of
the cost elements and input parameters. Using current freight rate
structures, the cost of capital and operating procedures for the
companies can all be converted to dollar values.
(5) Step 5. Calculate the annual total logistics cost for moving materials
between the parent company and the JV for each particular transportation
mode, and construct a cost matrix containing the logistics cost of moving
materials in both directions. As an immediate result, the most economic
transportation mode can be identified from the cost matrix.
In addition to the cost matrix, the computational results can also help obtain a
series of percentages of the logistics cost relative to the values of raw materials,
value-added services, or the finished parts, respectively. These percentages are
extremely useful in evaluating the effectiveness of sourcing alternatives as well
as providing increased awareness of the importance of the total logistics costs.
These percentages can be calculated in the following way:

vr

vVA

vf

Annual logistics costUS!CN $=Annual demand units


;
Original value of a raw material $=unit

Annual logistics costCN !US $=Annual demand units


;
Added value by the JV $=unit

Annual total logistics cost $=Annual demand units


:
Value of finished part $=unit

5. Implementation of the framework


The preceding section has described the evaluation framework of total logistics
costs in detail. In this section we will explain and demonstrate how the
quantitative part of the framework, step 5, can be implemented on
spreadsheets, such as MS-Excel.
5.1 The spreadsheet model
For the purpose of illustration, we will only show how step 5 is completed for
air shipment. The computations for other transportation alternatives follow the
same routine, and hence will not be repeated and demonstrated. The related
data are collected from the two companies but are slightly modified for the
protection of confidentiality.

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The entire calculation consists of four sections, as shown and explained in


Table III-VI. The first section is the input area, which is common for all
transportation options under evaluation. There are two parts in this section.
The first contains the nine general input parameters, which serve as inputs for
subsequent analysis and are used for all computations for each transportation
mode of interest. An important parameter in this part is the annual shipping
frequencies of raw materials and finished parts. Although this could be a
decision variable that deserves a great deal of investigation, we assume that the
values are known and determined by the logistics managers. For our
demonstration we assume that the inbound and outbound annual shipping
frequency equals 150, which is close to the current practice of company P. The
effect of the shipping frequency on the logistics cost and mode selection will be
discussed in the section of sensitivity analysis. The second part contains
immediate results derived from the data in the first block.

Raw material costs $/unit


Finished product price $/unit
Cost of capital JV (%)
Cost of capital parent company (%)
Total yearly demand (units)
Weight of finished part (kg)
Weight of raw material (kg)
Shipments raw material/year
Shipments finished parts/year
Manufacturing time (wks)
Value raw material per shipment ($)
Value finished part per shipment ($)
Weight of raw material shipment (kg)
Weight of finished part shipment (kg)
Equivalent raw material/shipment
Table III.
Calculating the logistics No. finished parts/shipment
cost for air shipment on Shipments raw material/year
Shipments finished parts/year
spreadsheets.
Manufacturing time (wks)
(1) Input area

Kg
Table IV.
Calculating the logistics
cost for air shipment on
spreadsheets.
(2) Parameters for a
specific transportation
mode

USA to China $/Kg


China to USA $/Kg

USA to China
China to USA

Min
90
75

0
4.65
5.6

Transit times
(days)
6
6

1,000
3,000
10
12
2,900
29
30.5
150
150
6
19,333
58,000
590
561
19
19
150
150
6

45
4.1
5.2

100
3.25
4.8

Loss and
damage
(%/$)
0.50
0.50

250
3.1
4.7

500
2.95
4.6

1,000
2.8
4.4

2,000
2.8
4.35

Weight
($)

Frequency
($)

1,739.52
294.83

16.00

Value
($)

256.00

Description

2.95
0.5

$/kg
$/shipment and kg

Weight rate
Pickup delivery
charge
Storage
797
Brokerage fees
Order processing cost
Terminal handling
charge
Material handling
Communication cost
Overhead
Allocation fee
Airport transfer
In/out handling
Packaging/supplies
material
Duties/tariffs
Damage/loss/delay
Insurance
Pipeline inventory
cost (transit + mfg.
Table V.
time)
Calculating the logistics
Safety stock holding cost for air shipment on
cost
spreadsheets.
(3) Calculation

$/kg
$/shipment
$/shipment
$/shipment

483.33

25
25
25
15
5
5
(2.5)

$/shipment
$/shipment
$/shipment
$/shipment
$/shipment
$/shipment
Percent value

96.67
6.77
343.23

0
(0.50)
(0.035)
(1.78)

Percent value
Percent value
Percent value
Time/value

15.47

(0.08)

Time/value

25.00
25.00
25.00
15.00
5.00
5.00

2,034.35

Units

0
60
50
30

60.00
50.00
30.00

945.47

Logistics cost per shipment


12 mos. present value
18 mos. present value
24 mos. present value
60 mos. present value

Evaluating the
logistics costs

Rate
(%)

Table VI.
$3,236 Calculating the logistics
$457,209 cost for air shipment on
spreadsheets
$666,051
(4) Conversion to
$862,736
present values
$1,824,421

The second section consists of the air freight-rate schemes for both inbound
and outbound shipments, transit times, and the rates of loss and damage. The
data in this section should be modified based on the transportation mode being
considered. The associated calculations of all cost elements re-classified as the
weight-based, frequency-based, and value-based are illustrated in the third
section. Note that the same calculation is required for inbound and outbound.
What is shown here is the calculation of logistics cost for moving materials
from the USA to China and the result is a conversion of all cost items into dollar
values on a per-shipment basis.
In the last section, the logistics cost per shipment is obtained as the sum of
the three classified costs. If payment frequency is not parallel with the

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shipment frequency, then the present values of logistics cost can be used for
comparison. The present values can be obtained easily using the built-in
function PV in Excel. The interest rate used for this calculation is the hurdle
rate of company P since it is assumed that these costs will be compared to costs
of other suppliers as well as other logistics alternatives. If comparing the total
logistics costs of all available transportation alternatives is needed, then the
same calculation routine exhibited in Table II should be performed for each of
the alternatives. The final results can be organized into a cost matrix, as shown
in Table VII. The figures in italics are the logistics cost of moving materials in
one direction, whereas others are the sums of logistics costs of the two
directions. In particular, the numbers on the diagonal indicate the total logistics
cost if the same transportation mode is used for both directions. This cost
matrix can be used to identify the most economic combination of shipping
options on the assumption that the values of all required parameters are known
with certainty. In this case, the lowest total cost equals $975,925 per year.
Frequently transportation/logistics managers are concerned with the
percentage of the value of the outsourced parts that is spent on the logistics
activities, which is also an excellent measure of the soundness of the
transportation policy. To get a better perspective on the weight of logistics cost
relative to the original value of raw materials, value added through
manufacturing, and the finished parts, we have calculated the three
percentages using the equations (1)-(3) using the spreadsheets. We have
found the following results:
.
The raw material logistics costs percentages range from 12 percent to 41
percent, the highest value corresponding to full container shipments via
inland transport by rail due to low shipment weight and the high
per-shipment cost of the full container.
.
The logistics costs of the value-added portion of the finished parts range
from 11 percent to 23 percent.
.
The resulting total logistics cost can be as high as 29 percent of the value
of the finished product.

To China

Table VII.
The cost matrix for all
available transportation
alternatives

Air
WRF
WRL
WKF
WKL

Air ($)
One year PV ($)
457,209
1,177,046
384,740
1,062,104
362,052

717,479
1,174,687
1,894,524
1,102,219
1,779,583
1,079,531

From China
WRF ($)
WRL ($)
1,350,363
1,807,572
2,527,409
1,735,104
2,412,467
1,712,416

676,922
1,134,130
1,853,967
1,061,662
1,739,026
1,038,974

WKF ($)

WKL ($)

1,097,349
1,554,558
2,274,394
1,482,089
2,159,453
1,459,401

613,873
1,071,082
1,790,919
998,613
1,675,977
975,925

In summary, all these percentage values imply that logistics costs comprise a
significant portion of the total global sourcing cost, and thus should be carefully
tallied in order to understand the effectiveness of the global sourcing practice.
5.2 Sensitivity analysis
In a realistic business environment, the changing values of some of the key
parameters may significantly alter the final decision regarding the mode
selection and the magnitude of the logistics costs. In this section, we show that,
based on the calculations presented in the preceding subsection, sensitivity
analysis of the impacts of a number of the important parameters on the annual
logistics cost and most economic transportation mode can be performed. The
parameters chosen for examination include the shipping frequency, the annual
unit demand, the weight of the product and raw materials, and the product
value. The results derived from the sensitivity analyses are summarized and
reported in Table VIII. In the table, in refers to materials movement to China,
whereas out refers to the shipment of goods out of China, additionally, a
check mark indicates the most economic transportation mode.
In the first analysis, shown in Table VIII(a), we varied the shipping frequency
while keeping all other input variables constant; annual demand was 2,900 units,
finished goods weight was 29kg per unit, average raw material cost was $1,000
per part and average finished part price was $3,000. As the shipping frequency
increases, the shipping weight decreases, the value per shipment decreases, and
the annual shipment costs increase. As would be expected, with lower
frequencies, the model shows that full container shipment is most economical. As
shipment frequency increases, the high cost of transporting the less-than full
container far outweighs any savings derived from the flat rate structure. This has
the effect of making less-than container load shipments the most economical but
even at extremes, increasing shipping frequency does not promote air shipment.
The second analysis, shown in Table VIII(b), reveals the effects of increasing
total demand on choosing the best mode of transportation. The same inputs
were used as in the previous analysis except that the shipping frequency was
constant at the companys current operating strategy shipping raw materials
50 times per year and finished goods 150 times per year. Increasing demand
caused the size of each shipment to increase in weight and value. This caused
linear increases in total logistics costs for all modes of transportation. However,
full container load modes increased at a lower rate showing that at high
demand levels, full container loads become the most economical transportation
solution independent of shipping frequency within the limits of the model.
Our third analysis, shown in Table VIII(c), demonstrates the effect of
increasing the average unit weight on the best transportation mode while
maintaining the inputs from the previous two analyses. This analysis also
reveals the importance of part selection to the joint venture by the parent
company. As the weight per unit part increases, the total logistics costs
increase at a much slower rate. At a unit part weight of 175kg, the water-truck

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Mode
(A) The effect of shipment frequency on the choice
of the best shipping mode
Frequency (in)
12
24
52
100
150
Frequency (out)
12
24
52
100
150
(B) The effect of annual demand on the choice of
the best shipping mode
Demand (1,000) (in)
1
2
3
4
5
Demand (1,000) (out)
1
2
3
4
5

Table VIII.
Sensitivity analyses

(C) The effect of shipping weight on the choice of


the best shipping mode
Weight (in)
105
131
158
184
210
Weight (out)
100
125
150
175
200

Air

WRF

WRL

WKF

WKL

(continued)

Mode
(D) The effect of product value on the choice of the
best shipping mode
Value (in)
84
167
333
1,667
3,333
Value (out)
250
500
1,000
5,000
10,000

Air

WRF

WRL

WKF

WKL

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full container load becomes the most economical mode of inbound


transportation. Furthermore, as the part weight continues to increase, the
low cost outbound mode will transfer to full container load shipment.
Lastly, Table VIII(d) shows the effect of increasing average unit part price
on the choice of the best shipping mode while maintaining the same constants
as used in the previous analyses. By varying unit part price, we are directly
affecting the costs in holding pipeline inventory, damage/loss, and insurance.
As expected, a higher value of the finished products favor the air shipment.
It is seen that by following the evaluation framework developed in this
paper, one can easily examine the effects of any important input parameters on
the resulted total logistics cost and the best shipping mode. The spreadsheet
model offers substantial flexibility to accommodate any changes in the general
or specific parameters, and the results provide excellent guidelines for involved
trading partners to revise or evaluate their logistics decisions.
6. Discussions and conclusions
As global sourcing becomes a prerequisite for companies competing in todays
market, understanding the cost-effectiveness of this procurement strategy has
drawn a great deal of interest. This paper relies on a case study at a leading
company in the US aviation industry and one of its international manufacturers
in China as a basis to derive an evaluation framework for assessing the
effectiveness of global sourcing.
The newly developed evaluation framework consists of five steps. The
implementation of the computational segment of the framework on
spreadsheets in the last step is explained in detail in the previous section. As
stated previously, this framework is general enough to be readily adapted for
different companies and operational scenarios. For example, the logistics cost
categories may remain the same but the elements of each category can vary

Table VIII.

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from case to case. The number of potential transportation modes may also vary
in different situations. We believe that the classification of the cost items into
weight-based, value-based and frequency-based provides an easy way to
quantify both qualitative and quantitative factors, which can be measured on
one numerical scale. In some other circumstances, distance-based factors can be
added or substituted for one of the classifications. The calculations are simple
routines on the spreadsheets and provide the logistics managers with various
perspectives on the landscape of the global sourcing strategy.
The computational part of the framework can be easily implemented on
spreadsheets and offers substantial flexibility to accommodate assessment of
various transportation alternatives and sensitivity analysis. Although this
spreadsheet-based evaluation procedure is established based on a particular
companys situation, it can be revised easily and is applicable to companies
that are practicing global sourcing strategies.
It is necessary to mention that the newly developed framework relies on a few
assumptions and has a number of limitations. First of all, the demand
information on the engine parts must be a known constant, and these data also
serve as one of the critical input parameters. Second, the transportation routes
are predetermined and fixed. In other words, the new framework needs to be
modified substantially before it can be used to evaluate and compare possible
shipping routes. Third, the values of all required input parameters such as those
listed under section 4.2 should be available to enable the calculations. Finally,
there are many other factors critical for decision making and yet cannot be
incorporated into the calculation procedures. For example, the entire
transportation infrastructure in China, the reliability and reputation of the rail
and trucking carriers, the regulations and local laws, the accuracy of demand
forecasting, to name just a few, are extremely crucial for transportation mode
selection and the evaluation of the effectiveness of global sourcing strategy. The
framework developed in this paper can only provide references and supporting
information for the logistics decision-making process such as all relevant
logistics cost items and the ways of quantifying each of the cost elements.
The limitations discussed above indicate the directions for possible future
research. The immediate expansion of the current evaluation framework can be
pursued from two perspectives: one is to consider the stochastic demand to
accommodate the realistic demand pattern and the forecasting accuracy, and
the other is to include the evaluation of possible transport routes so that the
framework allows the selection of both shipping mode and route. The study of
these two areas is currently underway.
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