Total Cost Approach to Logistics

Total cost approach to logistics is the key to managing the logistics function. Management should strive to reduce the total cost of logistics rather than the cost of each activity. So logistics must be viewed as an integrated system rather than the individual system, because reduction in one cost invariably lead to increase the cost of other components. Effective management and real cost savings can be accomplished only by viewing logistics as an integrated system and minimizing its total cost given the firms customer service objectives. So the main costs which are involved in logistics function are:

  1. Customer service level costs
  2. Transportation costs
  3. Warehousing costs
  4. Order processing and information costs
  5. Lot quantity costs
  6. Inventory carrying costs

Customer Service Level Costs

Most business people find it difficult, if not impossible to measure this cost. The cost associated with alternative customer service levels is the cost of lost sales( not only the margin lost by not meeting current sales demand, but the present value of all future contributions to profit forfeited when a customer is lost due to poor availability, long lead times, or other service failures).

By comparing total logistics system costs, management can make knowledgeable judgment about the likelihood of recovering, through increased sales, the increase in total system costs brought about by an increase in customer service levels. Of course, management could also reduce spending in some other to component of the marketing mix – promotion, for example – in order to maintain profits with a similar sales volume. Likewise, with decrease in customer service levels, management can improve profitability or increase expenditures for other components of the marketing mix in an effort to maintain or improve market position. At the end the goal is to determine the least total cost method of logistics while keeping customer service objectives in mind.

Transportation Costs

Costs associated with the transportation function can be identified in total and be segments (i.e. inbound, outbound, by vendor, by customer, by mode, by carrier, by product, or by channel). This detail is necessary to determine the incremental costs associated with changes in the logistics system. If transportation costs are not currently available in any other form, management can determine them at a relatively low cost by sampling product flows and auditing freight bills (for common carriers) or corporate accounting records (for private fleets).

Warehousing Costs

Warehousing costs are all the expenses that can be eliminated or that must be increased as a result of a change in the number of warehousing facilities. Warehousing costs should be separated into two distinct categories:

  1. Throughput Costs: These costs are associated with selling product in a given market by moving it into and out of a warehouse in that market, and the fixed costs associated with the facility. Example is charges that public warehouses assess for moving product into and out of their facilities, and the costs of leased and owned facilities for the movement of the goods.
  2. Storage Costs: Warehousing costs related to inventory storage should be included in inventory carrying costs. These warehousing costs change with the level of inventory held in a specific warehouse and tend to be negligible in a company- owned or leased warehouse.

Throughput costs should be included instead in warehousing costs so that the increments can be easily added or subtracted when the logistics system configuration system changes.

Order Processing and Information Costs

Order processing and information costs include the cost of order transmittal, order entry, order processing, related handling costs, and associated internal and external communication costs. When establishing these costs management should remember to include in the analysis only those costs that will change with decision being made.

Lot Quantity Costs

Lot quantity costs are those production related or purchasing/acquisition costs that will change as a result of a change in the logistics system. Generally it consists of production preparation costs, capacity lost due to changeover, materials handling, scheduling and expediting. The lot quantity costs associated with purchasing are the costs of buying in various quantities.

Inventory Carrying Costs

Conceptually inventory carrying costs are the most difficult costs to determine next to the costs of lost sale. Inventory carrying costs should include only those costs that vary with the level of inventory stored and that can be categorized into 4 costs.

  • Capital costs
  • Inventory service costs
  • Storage space costs
  • Inventory risk costs.

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