7.9 Tools: Total Logistics Costs

Transportation is big business. In the U.S., transportation represents 63% of the total logistics bill ($890 million / $1.41 trillion). Thus, some managers say, "In logistics, you're only as good as your transportation." What's your takeaway? Because logistics is often managed as a cost center, you may be tempted to do everything possible to reduce transportation costs. After all, transportation is your biggest cost bucket and every dollar saved in transportation goes straight to the bottom line—right? Let's take a closer look at some tradeoffs you might encounter.

Let's return to our carrier-selection example. You can clearly reduce cost by choosing the carrier "In Your Dreams." However, you will pay a price in reliability and delivery cycle time that will require you hold more inventory. You probably will also miss some customer delivery time windows. Customers may take their business to your rivals. In other words, saving money in transportation can hurt you elsewhere. Not all cost savings are the same. You want to make decisions that lead to the best overall outcomes.

Now, let's consider a different scenario: The effect of adding more distribution locations to our business. You need to answer two questions:

• If you add a new distribution point, what other activities/costs will be affected? Answer: Adding a distribution point is likely to affect transportation, inventory, warehousing, order processing, and customer service.

• How will these costs be affected? Figure 7-13 suggests the likely outcomes when the number of distribution points in a logistics system changes. Adding distribution points tends to increase order processing, warehousing, and inventory carrying costs. However, customer service should improve, reducing your cost of poor service. Early additions reduce costs dramatically. But, benefits diminish as you increase the number of locations to be closer to customers. Transportation costs are unique; that is, the cost curve is U-shaped.

What is the total cost impact? You simply need to add up the five costs to find out. Note that your lowest total cost occurs at point where NONE of the individual costs is at its minimum. So, if you focus on minimizing transportation costs, you will miss an opportunity to optimize your entire logistics system. This is the lesson of systems thinking applied to the cost of logistics.