By Dan Sobbott, Sr. Manager, Supply Chain Strategy Practice
Wednesday, July 6, 2011
Diesel fuel prices have been steadily rising since January 2009, and companies have used various supply chain management tactics to mitigate the associated costs (see the US Energy Information Administration’s Short-Term Outlook). Just recently, the national average price for diesel fuel topped $4 per gallon. This unfortunate milestone has prompted many companies to wonder if they should modify their supply chain network to reduce delivery miles.
To help answer this question, we created optimized models for seven distinct distribution networks. The companies included in the analysis represent a range of industries with associated cost structures and transportation mode mixes (see Figure 1: Network Cost Structures). We wanted to examine the impact fuel increases have on networks with more inventory working capital costs (29%) and less transportation costs (60%), such as high tech, as compared to industries like food and beverage where transport costs make up nearly 88% of overall costs . We considered a broad range of fuel prices — from $2 to $12 per gallon — to evaluate when major network changes like adding a DC made sense.
A static network creates substantial opportunity costs as fuel costs increase. Are networks designed at $2 per gallon still optimal when fuel reaches $6? We compared two sets of results as fuel costs rose from $2 to $6 per gallon: The first, doing nothing as fuel rose, was defined as a network optimally designed at $2 per gallon. In the second results, we optimized the network as fuel increased. “Doing nothing” resulted in the total loss of more than $25 million of opportunity costs across the seven networks. These costs varied significantly across the different networks, from a low of $0.2 million to a high of $12 million. Comparing “doing nothing” to an optimized network with fuel at $12 per gallon, the result was more than $80 million in opportunity costs.
If leaving a network as it was designed at lower fuel prices can deprive a company of cost savings, what changes should be made as fuel prices increase? More facilities? Different locations? Or simply utilizing existing networks differently?
Infrastructure changes to a distribution network are generally not the answer. Surprisingly, as fuel prices fluctuated from $3 to $12 per gallon, few networks required modifications to the number and location of DCs (see Figure 2: Recommended Infrastructure Changes). When the optimal number of DCs did increase, a single DC was added incrementally to the network, but existing DCs were not changed. Only the national retailer and food & beverage networks — those with the largest transportation percent costs –added facilities as fuel reached $5 per gallon. Not much of a stretch considering today’s fuel cost of $4 per gallon. The high tech network, the one with the lowest percent of transport costs, was the only network to decrease the number of DCs as fuel dropped from $4 to $3 per gallon.
Companies should focus on flow optimization opportunities to mitigate cost increases. The greatest opportunities were not driven by infrastructure changes, but rather by product flow changes. As fuel costs increased, the optimized results included several cost mitigation alternatives, including:
- Nearshore sourcing. As fuel costs rose for the high tech company, sourcing shifted from Asia to Mexico. The increases in procurement costs were more than offset by decreases in inbound transport costs and in-transit inventory costs on its high-value products.
- DC replenishment mode shift. The building products manufacturer shifted 7.2 million pounds from LTL to truckload in DC replenishment requiring a decrease in DC replenishment frequency. As fuel costs rose, the transportation benefits of this mode shift outweighed the incremental inventory holding and DC space costs.
- Manufacturing shift and change to DC replenishment. The food & beverage company saw a decrease in DC replenishment transport that was partially offset by an increase in DC-to-Customer transport.
- Customer service territory realignment. The CPG manufacturer decreased its average miles from DC-to-Customer by nearly 5% from $2 to $6 per gallon. To do this, manufacturing shifted among plants. While total manufacturing costs actually increased, outbound transport costs decreased.
- Change to zone skipping strategies. For the consumer fulfillment company, zone skipping became less attractive as fuel price increased because truckload costs increased at a faster rate than parcel ground costs.
The savings impact of these product flow changes are detailed in Figure 3.
Across these seven networks, more than $80 million in value was identified to mitigate the impact of rising fuel costs. Beyond this analysis, however, it is important to note that each network is unique and an in-depth understanding and continued analysis is required to make intelligent adaptations. While fuel prices of $12 per gallon seem unlikely, stranger things have certainly happened. In the early 1990s, to think of fuel prices at $4 per gallon would have seemed absurd and yet it’s today’s reality. With fuel price uncertainty, significant changes to your supply chain network won’t yield longstanding gains. However, a few insignificant modifications to flow paths can mitigate significant fuel costs.