PHYSICAL DISTRIBUTION SYSTEM

The objective of distribution management is to design and operate a distribution system that attains the required level of customer service and does that at least cost. To reach this objective, all activities involved in the movement and storage of goods must be organized into an integrated system.

Activities in the physical distribution system

In a distribution system, 6 interrelated activities affect customer service and the cost of providing it:

- Transportation. Transportation involves the various methods of moving goods outside the firm’s buildings. For most firms, it is the single highest cost in distribution, usually accounting for 30% to 60% of distribution costs. Transportation adds place value to the product;

- Distribution inventory. Distribution inventory includes all finished goods inventories at any point in the distribution system. In cost terms, it is the second most important item in distribution, accounting for 25% to 30% of the cost of distribution. Inventories create time value by placing the product close to the customer;

- Warehouses (distribution centers). Warehouses are used to store inventory. The management of warehouses makes decisions on site selection, number of distribution centers, layout and methods of receiving, storing and retrieving goods;

- Materials handling. Materials handling is the movement and storage of goods inside the distribution center. The type of materials handling equipment used affects the efficiency and cost of operating the distribution center. Materials handling represents a capital cost;

- Protective packaging. Goods moving in a distribution system must be contained, protected and identified. In addition, goods are moved and stored in packages and must fit into dimension of the storage spaces and the transportation vehicles;

- Order processing and communication. Order processing includes all activities needed to fill customer orders. Many intermediaries are involved

in the movement of goods and good communication is essential to a successful distribution system.

Total-cost concept

The objective of distribution management is to provide the required level of customer service at the least total system cost. What happens to one activity has an effect on other activities, total system cost and the service level. Management must treat the system as a whole and understand the relationship among the activities.

Rail

(10 days) Air (1 day) Transportation cost 200 1000 In-transit inventory-carrying cost

($10/day) 1000 100 Total 1200 1100

There are 2 related principles illustrated here:

- Cost trade-off. The cost of transportation increased with the use of air transport, but the cost of carrying inventory decreased. There was a cost trade-off between the 2;

- Total cost. By considering all of the costs and not just any one cost, the total system cost is reduced. Note also that even though no cost is attributed to it, customer service is improved by reducing the transit time. The total cost should also reflect the effect of the decision on other departments, such as production and marketing.

In this section, the emphasis is on the costs and tradeoffs incurred and on improvement in customer service. Generally, but not always, an increase in customer service requires an increase in cost, which is one of the major tradeoffs.

13.3 INTERFACES

There are several important interfaces among physical distribution and production and marketing.

Marketing

Although physical distribution interacts with all departments in a business, its closest relationship is probably with marketing.

The marketing mix is made up of product, promotion, price and place and the latter is created by physical distribution. Marketing is responsible for transferring ownership. Physical distribution has the responsibility of meeting the customer service levels established by marketing and the senior management of the firm.

Physical distribution contributes to creating demand. Prompt delivery, product availability and accurate order filling are important competitive tools in promoting a firm’s products. The distribution system is a cost, so its efficiency and effectiveness influence the company’s ability to price competitively.

Production

There are many factors involved in selecting a site for a factory, but an important one is the cost and availability of transportation for a raw materials to the factory and the movement of finished goods to the marketplace. Sometimes, the location of factories is decided largely by the sources and transportation links of raw materials. This is particularly true where the raw materials are bulky and of relatively low value compared to the finished product.

Although the demand from customers may be relatively uniform, the factory reacts to the demand from the distribution centers for replenishment stock. The distribution system is the factory’s customer and the way that the distribution system interfaces with the factory will influence the efficiency of factory operations.

13.4 TRANSPORTATION

Transportation is a major contributor to the economic and social fabric of a society and aids economic development of regional areas.

The carriers of transportation can be divided into 5 basic modes:

- Rail;

- Road, including trucks, buses and automobiles;

- Air;

- Water, including ocean-going, inland and coastal ships;

- Pipeline.

Each mode has different cost and service characteristics. These determine which method is appropriate for the types of goods to be moved.

Costs of carriage

To provide transportation service, any carrier must have certain basic physical elements. These elements are ways, terminals and vehicles. Each results in a cost to the carrier and, depending on the mode and the carrier, may be either capital (fixed) or operating (variable) costs. Fixed costs are costs that do not change with the volume of goods carried. The purchase cost of a truck is a fixed cost. However, many costs of operation, such as fuel, maintenance and driver’s wages, depend on the use made of the truck. These are variable costs.

Ways are the paths over which the carrier operates. The nature of the way and how it is paid vary with the mode. They may be owned and operated by the government or by the carrier or provided by the nature.

Terminals are places where carriers load and unload goods to and from vehicles and make connections between local pickup and delivery service and line-haul service. Other functions performed at terminals are weighing; connections with other routes and carriers; vehicle routing, dispatching and maintenance; and administration and paperwork. The nature, size and complexity of the terminal varies with the mode and size of the firm and the types of good carried. Terminals are generally owned and operated by the carrier but, in some special circumstances, may be publicly owned and operated.

Vehicles of various types are used in all modes except pipelines. They serve as carrying and power units to move the goods over the ways. The carrier usually owns or leases the vehicles, although sometimes the shipper owns or leases them.

Rail

Railways provide their own ways, terminals and vehicles, all of which represent a large capital investment. This means that most of the total cost of operating a railway is fixed. Thus, railways must have a high volume of traffic to absorb the fixed costs.

Therefore, railways are best able to move large volumes of bulky goods over long distances. Rail speed is good over long distances, the service is generally reliable and trains are flexible about the goods they can carry. Train service is cheaper than road for large quantities of bulky commodities moved over long distances.

Road

Trucks do not provide their own ways but pay a fee to the government as license, gasoline and other taxes and tolls for the use of roads. Terminals are usually owned and operated by the carrier but may be either privately owned or owned by the government. If owned, they are a major capital expense. However, in comparison to other modes, the cost of a vehicle is small. This means that for road carriers most of their costs are operating (variable) in nature.

Trucks can provide door-to-door service. They are particularly suited to distribution of relatively small-volume goods to a dispersed market.

Air

Air transport requires an airway system that includes air traffic control and navigation systems. These systems are usually provided by the government. Carriers pay a user charge that is variable cost to them. Terminals include all of the airport facilities, most of which are provided by the government. However, carriers are usually responsible for providing their own cargo terminals and maintenance facilities, either by owning or renting the space. The aircraft are expensive and are the single most important cost element for the airline. Since operating costs are high, airlines’

costs are mainly variable.

The main advantage of air transport is speed of service, especially over long distances. Most cargo travels in passenger aircraft and thus many delivery schedules are tied to those of passenger service. Transportation cost for air cargo is higher than for a other modes. For these reasons, air transport is most often suitable for high-value, low-weight cargo or for emergency items.

Water

Waterways are provided by nature or by nature with assistance of the government. The carrier thus has no capital cost in providing the ways but may have to pay a fee for using the waterway.

Terminals may be provided by the government but are increasingly privately owned. The carrier will pay a fee to use them. Thus, terminals are mainly a variable cost. Vehicles are either owned or leased by the carrier and represent the major capital or fixed cost to the carrier.

The main advantage of water transport is cost. Operating costs are low and, since the ships have a relatively large capacity, the fixed costs can be absorbed over

consignee are on the waterway. Therefore, water transportation is most useful for moving low-value, bulky cargo over relatively long distances where waterways are available.

Pipelines

Pipelines are unique among the modes of transportation in that they move only gas, oil and refined products on a widespread basis. Capital costs for ways and pipelines are high and are borne by the carrier, but operating costs are very low.