APPENDIX A.  INTEGRATING SUPPLY CHAIN BENEFITS INTO ECONOMIC ANALYSIS

A.1 Synopsis – A Framework for Assessing the Supply Chain Benefits of Transportation Infrastructure Projects

Traditional transportation and economic impact modeling has addressed the impacts on industry somewhat irregularly, with few studies addressing exactly how businesses benefit from improved transportation. This appendix explains and quantifies the industry impacts from transportation improvements with emphasis on supply chain effects. Companies have been successfully leveraging supply chain principles for cost savings and service improvement for over 20 years. The supply chain effects of transportation improvements are a critical element of that improvement and this analysis provides needed information on the logistics (also know as second order effects) benefits to industry.

Transportation projects deliver supply chain benefits by lowering transportation costs, by alleviating capacity bottlenecks, and by enhancing in-transit visibility.

Shippers use lower transportation costs to source from less expensive suppliers, which increase their margins. They also deliver at lower costs per shipment. They operate fewer plants because they get greater market reach from each one, thereby reducing assets and increasing return on assets. They also opt for smaller shipments, which had been prohibitively expensive, and thereby decrease inventory again.

Shippers use freed-up capacity from fewer bottlenecks to reduce inbound variability of arrival times, which results in less inventory. Less variability allows them to reduce the size of fleets because they need fewer vehicles for peak-period congestion, as well as fewer spares. And with less variability they reduce warehouse space that held inventory that was buffering against the unreliability of inbound shipments due to potential congestion.

The secondary effects create even more benefits for shippers than these supply chain cost and service advantages. Shippers reinvest the cash savings in price reductions, thereby becoming more competitive, which increases sales and profits. They increase service levels at no cost, or at low cost, thereby increasing customer satisfaction and loyalty. And they create flexible, nimble, on-demand supply chains based on small order quantities, resulting in sustainable competitive advantage.

Supply chain benefits accrue unevenly because companies’ logistics configurations vary widely. However, planners can assess the supply chain impact of individual projects by classifying the affected population of companies into six Supply Chain Types™, and quantifying the supply chain impact of projects on companies of each Type. The six categories are: Extraction, Process manufacturing, Discrete manufacturing, Design-to-order manufacturing, Distribution, and Reselling. And each type of supply chain reacts differently to an economic stimulus such as reduction in transportation cost.

Two follow-up research efforts are recommended for consideration. The first is to refine the mapping of the six Supply Chain Types to NAICS industry definitions and consider how this varies by region. The second is to develop a method for quantifying the revenue benefit of supply chain improvements.

A.2 Why Supply Chain Effects Are Important Today

Supply chain management trends have re-shaped the way shippers manage their logistics function over the last 10 to 20 years. Supply chain management as a whole emerged as an outgrowth of distribution, followed by logistics, and then the “extended enterprise.”

Three supply chain trends have dominated the agenda of supply chain professionals due to their ability to generate cost savings and improve customer service. These are strategic sourcing, lean manufacturing and distribution, and in-transit visibility.

• Strategic sourcing has become a mature and embedded process in most companies because of the cost reduction pressure placed on manufacturers as a result of our transition to a service economy and the consequent commoditization of goods. Recently, strategic sourcing has focused primarily on global sourcing and off-shoring, which has led to more imports.
• Lean manufacturing and distribution has enjoyed popularity since the Japanese auto industry overtook the American carmakers in the 1970s. Lean supply chain concepts include just-in-time (JIT) principles to reduce inventory, total quality management, and statistical process control. Extensions of the concept have led to Efficient Consumer Response (ECR) in the retailing industry, flexible manufacturing, postponement, assembly-to-order, and cross-docking. Lean manufacturing’s quest for a “one-piece flow” has led to a new paradigm of “mass customization,” which is predicated on smaller lot sizes and smaller shipments, and producing only what the customer wants when he or she wants it.
• In-transit visibility, which originally attracted attention as a technology investment during the Internet boom, has grown due to its capacity to improve customer service and simultaneously reduce costs. Intelligent transportation systems track vehicles, equipment, and cargo.

A.3 How Shippers Convert Transportation Benefits into Competitive Advantage Via Their Supply Chains

Just as strategic sourcing, lean manufacturing and distribution, and in-transit visibility can lower transportation and/or logistics costs, investments in transportation infrastructure can magnify and accelerate the benefits realized by these programs.

Given lower transportation costs, shippers will set up and operate their networks more efficiently. They will:

• Source from less expensive suppliers that are farther away. Lower transportation costs help shippers source from more efficient but more distant suppliers, and reduce shipment size and inventory, thereby creating Lean benefits.
• Operate fewer, larger plants at the same delivered price and relocate existing plants to lower-cost areas. Global competition has led to larger-scale manufacturing plants at lower manufactured cost per unit. Therefore, transportation costs are becoming a larger part of the site location cost equation through the delivered cost per unit (transportation represented 51 percent of logistics costs in 1984 and 63 percent in 2004).²⁷ Any infrastructure that lowers the cost of getting freight from one place to another supports a more efficient use of plant capacity.
• Reduce average shipment size, adding to manufacturing flexibility.

Given additional transportation capacity and fewer bottlenecks, shippers will create “lean” supply chains that:

• Shift warehouse stock to in-transit inventory (increase velocity of product through the chain), which further reduces warehouse operating cost, which reduces the need for logistics overhead.
• Rationalize the vehicle fleet and the warehouse labor needed to serve the same customer demand. Because shippers get more turns from the existing vehicle fleet, they need fewer vehicles and drivers. Because average transit time is reduced by eliminating bottlenecks, shippers can do more same-day and overnight cross-docking, so they can reduce warehouse space and labor. With cross-docking, they may even be able to set tighter delivery time windows and thereby reduce receiving staff.

Figure A.1 How Shippers Leverage Transportation Infrastructure Improvements for Supply Chain Advantage

Source: Boston Logistics Group, Inc.

Realizing the benefits from transportation improvements can take up to 24 months after the completion of an infrastructure project. In addition, companies may need to make a substantial financial investment or organizational change to achieve the benefits. A timeline of benefits would look something like this:

• Month 3: Switch to cheaper materials. It often takes a few months to identify alternative suppliers for a material or product
• Month 6: Reduce inventory. Shippers often have monthly “production, sales, and inventory” that determine when, where, and how much inventory is held.
• Month 9: Consolidate fleet. Based on a 12-month rolling cycle where vehicles come off lease and tags expire, creating the conditions for fleet rationalization.
• Month 12 to 24: Consolidate facilities. Physical consolidation will depend on budget cycles, financing, and long-term planning, and may stretch over two or more cycles.

In addition to these specific benefits, shippers obtain substantial “shadow” benefits from all of these programs in three forms. They will:

• Convert cost savings into price reductions, thereby stimulating demand and revenue growth.
• Leverage lower transportation costs to offer better service levels for the same price, OR same service level for lower price, OR higher service levels for higher price; and shorter order-to-delivery lead-times.
• Create “on-demand” supply chains where flexible manufacturing and distribution results in less waste and more sales at higher margins by ensuring that the right product is in the right place at the right time.

A.4 Leveraging Lower Transport Costs

Sourcing From Less Expensive Suppliers, Increasing Margins

The benefits from strategic sourcing are well-documented. Often, distant suppliers can offer lower prices as economic conditions vary across regions. Furthermore, savings from global sourcing are much greater than those from domestic sourcing.

However, transportation costs usually disadvantage distant suppliers, even if their prices are lower, because transportation costs neutralize the price differences. As distance increases, the ratio of transportation cost to material or product cost increases, discouraging buyers from contracting with far-away suppliers. The farther the supplier, the greater the transportation disadvantage.

A one-day delivery range is about 600-800 miles (see Figure A.2), which is a function of the number of over-the-road hours that can be driven in a day by long-haul truckers.

Figure A.2 Truck Delivery Zones by Number of Days from Chicago

Source: FedEx.

Note: Each color represents one day of delivery time red = 1 day, blue = 2 days, etc.)

While manufacturers will eliminate potential suppliers due to their distance, lower transportation costs make those suppliers eligible and competitive. Lower transportation costs enable shippers to buy from less expensive suppliers that are farther away. The extent of sourcing savings from lower-cost transportation depends on the amount of external “spend,” the savings from sourcing farther away, and the extent of the reduction in transportation cost. Lower transportation costs also allow companies to have a broader range of supplier options, and hence product differentiation. This is especially true for companies in bulk or heavy commodities such as steel, wood, paper, or furniture.

Operating Fewer Plants, Increasing Return on Assets

When manufacturers or distributors decide how many sites they need to serve a geographical area, they balance the tradeoffs between facility operating and capital costs, which generally increase with the number of facilities, and transportation costs, which often decrease with the number of facilities.

Figure A.3 shows how the number of sites decreases as a result of a decrease in transportation costs. As the inbound transport costs decrease, the I/B cost curve shifts down. As the outbound transport costs decrease, the O/B cost curve shifts down. At the new levels of inbound and outbound cost, the Total Cost curve shifts down and to the left, resulting in the minimum part of the cost curve shifting to the left, from x to y. If inbound and outbound transport costs were identical and there were no other costs involved, the Total Cost curve would simply shift down, leaving the minimum point unchanged at x. The degree of lateral shift, and hence the potential for site reduction, depends on the proportion of asset, inventory, warehouse operating, inbound transportation, and outbound transportation costs, as well as the shape of the demand curve for each of them.

Figure A.3 Site Location Cost Drivers

Source: Boston Logistics Group, Inc.

Reducing Shipment Size, Decreasing Inventory

Lower transportation costs enable shippers²⁸ to ship smaller shipments at the same cost that they would have spent for a larger bulk shipment.²⁹ Smaller shipments lower the average order quantity both on the supply and the demand side, thereby lowering the average level of inventories. Smaller shipment sizes and order quantities also create other benefits that are addressed in “Secondary Effects,” including a more responsive supply chain that results in higher order fill rates and a wider product mix that results in more orders, sales, and profits.

Shipment size issues primarily affect inbound transportation. Customers usually have control over shipment size and cost on the outbound side, even if they are not paying for the freight. However, it is possible that the shipper could lose sales, or his customers might decide not to place the orders, because the order cycle time is too long due to a long transportation lead time driven by consolidation into large shipment sizes.

A.5 Leveraging Capacity from Fewer Transportation Bottlenecks

Increasing Inbound Reliability, Resulting in Less Inventory

Transportation bottlenecks create an alternating flow of “blocking” (excess inventory) and “starving” (stock-outs). Shippers compensate for transportation bottlenecks by holding extra inventory. By increasing the reliability of inbound lead-times (reducing the variability of arrival times), shippers reduce the amount of safety stock they must hold. Uncertainty of supply consists primarily of transportation lead-time, and secondarily of the suppliers’ requirements for production lead-time. The variability of transportation lead-time can be measured in standard deviations from the mean delivery lead-time. When there is high variation in the delivery lead-time, standard deviation is high and the bell curve is relatively flat. Intermodal traffic typically has a large degree of variability (see Figure A.4). In contrast, truckload and LTL transits are usually shorter and more predictable. Air shipments are the quickest and the some would argue the most predictable (the smallest standard deviation).

Figure A.4 Transit Time and Variability by Mode

Source: Boston Logistics Group, Inc.

Although many shippers have switched modes to achieve more predictable lead-times, effective transportation policy that reduces bottlenecks can achieve similar reductions in variability on existing modes.

Rationalizing Fleet and Warehouse Assets, Increasing Return on Assets

With less variability of supply, shippers need fewer spare vehicles and fewer vehicles to handle peak demand. Spares substitute for vehicles that are in maintenance, while extra vehicles buffer against demand spikes. In addition to reducing safety stock, receivers of freight can schedule time windows and expect carriers to meet them, as well as reduce the warehouse footprint and the associated logistics overhead.

A.6 Secondary Effects

For many companies, achieving direct cost reductions from supply chain programs is only the beginning of the economic benefit. In addition to the aforementioned benefits, shippers and receivers get additional benefits from investing savings in price reductions, increasing service levels, trimming logistics overhead, and creating additional sales with “on-demand” supply chains. Additional information on secondary effects is provided in the full technical memorandum on supply chain benefits, but given the lack of available/reliable estimates of the effects, it has been left out of this section of the report.

A.7 Size of the Overall Supply Chain Benefit

If shippers were to aggressively pursue every benefit, a 10 percent reduction in transportation cost could create a very significant reduction in shippers’ operating costs through a combination of these multipliers (see Table A.1), which are in addition to the direct transportation benefit.

Table A.1 Rough “First-Cut” Estimate of the Supply Chain Benefit from a 10 Percent Transportation Improvement

Source: Boston Logistics Group, Inc.

Note: These benefits are indicative and preliminary estimates only that are based on average companies in a broad cross-section of industries, including many that have little transportation cost and don’t move physical product. More precise estimates that are targeted at specific Supply Chain Types™ should be developed using the tools referenced throughout this text.

Financially, shippers appear to get the most leverage from using transportation cost benefits to access lower-cost sources of supply, consolidate facilities due to greater market reach, and to reduce inventory through smaller order quantities. Therefore, infrastructure projects that help shippers improve their access to low-cost sources of supply and reduce their inventory and warehousing costs have significant supply chain leverage.

Secondary benefits, though not quantified, may be more significant than the primary benefit. Re-investment of cost savings in price reductions and increased service levels helps make companies more competitive. However, the value of “on-demand” supply chains was not estimated in this paper due to the amount of primary research that would be required to develop benefit estimates that would be acceptable to a broad range of practitioners.

Companies must invest time and money to realize the full benefits made possible through transportation infrastructure improvement. Boston Logistics Group survey data shows that companies that focus on improvement efforts earn four times the payback of those that make ad-hoc efforts. So while some benefits will accrue “automatically” to shippers, many will take longer and require deliberate adjustments to their supply chains.

How to Quantify Supply Chain Benefits for Specific Types of Shippers

Classifying the affected population. Boston Logistics Group’s framework of supply chain types categorizes companies by their supply chain characteristics, as shown in Figure A.5. The chart identifies six unique Supply Chain Types™: 1) extraction; 2) process manufacturing; 3) discrete manufacturing; 4) design-to-order manufacturing; 5) distribution; and 6) reselling.

Figure A.5 Classification of Shipper Types

Source: Boston Logistics Group, Inc.

Four variables differentiate the types:

1. Production strategy (flow/continuous versus batch/cellular);
2. Transportation mode (ship/railcar, truckload/intermodal, or LTL/small package/air);
3. Order trigger (make to plan, make to stock, assemble to order, make to order, or engineer to order); and
4. Breadth of coverage between the raw material supplier and the end consumer.

Companies respond differently to transportation infrastructure investments depending on their supply chain types.

Extraction. Extraction-oriented companies mine, handle, and/or transform primary raw materials. Product values and inventory values are low, while transportation costs are high as a percentage of delivered cost to the customer. They operate large-scale physical plants. They often use modes such as barge and rail. Sample industries include mining, agriculture, and energy. Price elasticity is high due to the commodity product, so they benefit significantly from transportation cost reductions.

Process Manufacturing. Process manufacturers are capital-intensive and operate few plants (maybe even one), and as a result transportation is a large share of the delivered price, so market reach is an important driver of profitability. Reliability and predictability reduce costs, so they seek more consistent transit times in order to help synchronize the flow of transportation and inventory with the pace of production. Process manufacturers are often found in the chemical, gas, steel, and processed food industries.

Discrete manufacturing. Discrete manufacturers make and stock inventory, so inventory is a significant cost driver and they have or use a large vehicle fleet to move it around. Therefore, infrastructure projects that allow them to reduce inventory, transportation costs, or fleet assets, will have a big impact. Discrete manufacturers are the most common type of manufacturer.

Design-to-Order Manufacturing. Design-to-order manufacturers do not ship product until it has been ordered, and usually ship directly to customers. They are usually engineering-intensive, hold low inventory, and have few vehicles. They use transportation benefits to extend market reach of capital-intensive physical plants. Design-to-Order Manufacturers can be found in a wide range of industries including aircraft, construction, and defense.

Distribution. Distributors buy finished product, add value to it, and resell it in a transformed state. Even their “raw material” inventory is high-value, so the ability to move product quickly and reliably is their core competence. Therefore, any combination of transportation benefits will allow them to create supply chain advantages, and pure distributors may be the most affected by improvements in transportation infrastructure of any other Supply Chain Type™. Distributors can be found in almost every industry, including industrial, food, automotive, and apparel.

Reselling. Resellers buy finished product and resell it in its identical state. Resellers include retailers, e retailers, and direct mail advertisers. They spend relatively large amounts on transportation, largely because their retail outlets and/or their customers are so dispersed. They are responsible for inventory and have close collaboration with their consumer packaged goods suppliers. Resellers occur in many industries, including apparel, electronics, grocery, and restaurants.

If data is unavailable to estimate the number of firms of each of these types, a rough correspondence of the Supply Chain Types™ to NAICS Codes can be used (see Table A.2).

Table A.2 Approximate Matching of Shipper Type to Selected NAICS Codes

Source: Boston Logistics Group, Inc.

Note: Chart is indicative only and intended for use across broad sectors of the economy; data should be refined for application within individual industries. Shading indicates medium potential for category overlap.

Determining the Transportation Cost of the Affected Population

Since supply chain benefits are estimated as a percent of transportation cost, the baseline transportation cost of each affected industry (as classified by NAICS and translated into Supply Chain Types™) must be gathered. The key data to take into the next step of the analysis for each Supply Chain Type™ consists of the number of companies (or employees), their transportation cost, and direct transportation cost savings benefit.

Determining the Project’s Impact on Transportation Costs

To assess the impact of a given project on company’s supply chains, each of the benefits identified in this report is quantified using the global benefit ranges provided in Figure A.5 and the coefficients related to that Supply Chain Type™.

The benefits accrue in two categories: 1) benefits resulting from a reduction in transportation costs; and 2) benefits resulting from improved reliability.

• A reduction in transportation cost brings 1) greater supply network reach, 2) a reduction in the number of plants to serve the same market, and 3) a reduction in inventory from the use of smaller shipment sizes for the same price.
• Improved reliability brings: 4) a reduction in inventory and warehouses, as well as 5) a reduction in fleet assets

The next section describes the basic logic and key variables needed to compute simple, high-level valuations of each of these six unique supply chain benefits. Note that these are “top-down” approaches based on averages across survey data.

Greater Supply Network Reach

From Figure A.5, we know that the degree to which lower transportation costs allow a firm to access lower-cost suppliers equates to 1.5 percent of transportation cost. For a general mix of industries, we can apply this to the average amount of sales that comes from outside suppliers (52 percent). However, the impact on companies of various Supply Chain Types™ depends on the significance of externally purchased materials in their cost structures. Table A.3 shows the relative difference in external spending between companies in each Supply Chain Type™.

Table A.3 Externally Purchased Materials by Supply Chain Type™

Source: Boston Logistics Group, Inc.

For example, for a Process Manufacturing company the impact of a 10 percent transportation cost reduction could be calculated by multiplying the average cost savings (1.5 percent), by the relative amount of Externally Purchased Materials for Process Manufacturing companies, (0.86), to arrive at a savings that equates to 1.3 percent of transportation cost.

Reduction in Plant Assets. The degree to which a company will be able to reduce the number of plants that it operates depends on: a) the amount of fixed assets it owns; and b) the degree to which a reduction in transportation costs allows it to reduce them. The asset intensity of companies can be estimated by the ratio of Depreciation to Operating Costs, as represented by Sales minus Operating Income. Depreciation/Sales is a standard benchmark that can be obtained and modified by the operating ratio to arrive at Depreciation/Operating Costs. Table A.4 shows the asset intensity of companies by Supply Chain Type™.

Table A.4 Fixed Asset Intensity by Supply Chain Type™

Source: Boston Logistics Group, Inc.

To demonstrate the supply chain benefit calculation, assume an Extraction business with an asset intensity index of 1.54, and a savings from extended market reach that equated to 4 percent of transportation cost. The potential reduction from reduced transportation cost from plant consolidation would equate to 6.2 percent of transportation costs (1.54 multiplied by 4%).

Less Inventory Resulting from Smaller Shipment Sizes

The extent to which companies will reduce inventory by shifting to smaller shipment sizes depends on: a) the amount of inventory they keep on-hand; and b) the extent to which shifting to smaller shipment sizes will help them reduce it. Inventory on-hand is tracked and measured in numerous ways and published in a variety of periodicals and business almanacs. Table A.5 shows the inventory cost expressed as a percent of operating cost.

Table A.5 Value of Inventory by Supply Chain Type™

Source: Boston Logistics Group, Inc.

Using the data above for a Distribution business with an index value of 1.03, and applying the leverage factor of 1.20 percent, the benefit would equate to 1.24 percent of transportation cost.

Reduction in Inventory and Warehousing Costs from More Consistent Transit Times

The extent to which companies will reduce inventory due to more consistent transit times depends on: a) the amount of inventory they keep on-hand; and b) the extent to which more consistent transit times will allow them to reduce it. Therefore, assuming a Design-to-Order manufacturing company with an Inventory/Transportation Cost ratio of 1.09, and applying the average leverage factor of 1.1 percent, the benefit would equate to 1.2 percent of transportation cost.

Reduction of Fleet Assets

Companies’ ability to reduce fleet assets as a result of increased transit time reliability is a function of: a) fleet operating costs adjusted for the fleet size and demand peaking profile in inherent in different Supply Chain Types™; and b) the degree to which reliability allows them to eliminate vehicles by compressing turn times. Table A.6 shows the private fleet intensity for each Supply Chain Type™.

Table A.6 Private Fleet Expenses as a Percent of Operating Cost by Supply Chain Type™

Source: Boston Logistics Group, Inc.

For a Reseller with a relative fleet intensity of 1.0, and a savings from fleet rationalization of 0.3 percent, the potential reduction from reduced transportation cost from fleet rationalization would be 0.3 percent of operating costs (1.0 fleet intensity factor multiplied by 0.3 percent savings from reduced turn time).