January 2006 | Commentary | 3PL Line

Minimize Total Landed Cost: Strategize, Model, Act

Tags: 3PL

Total landed cost is the sum of all costs associated with making and delivering products to the point where they produce revenue—usually your customer's door.

So, if you employ tactics to reduce costs in all discrete functions from manufacturing through delivery, you'll have a lower total landed cost, right? Theoretically, yes. But in the real world, cost savings in one area often result in cost increases in another.

Raw materials and freight are cheaper in volume, for example. But warehousing and inventory costs go up when that volume lands on your dock. Conversely, show me a warehouse that operates on just-in-time deliveries, and I'll show you a high freight bill.

To find the lowest total landed cost, you have to think strategically. Rather than view your supply chain as a series of discrete functions, think of it as a whole. Your goal is to reduce the cost of that whole.

This approach helps you think outside the box. Rather than focus on lower warehouse costs, for example, you begin to wonder if you need that warehouse at all. That idea, in turn, sets off a chain of thoughts—transportation changes, stable inventory, different sources of raw material...you get the picture.

Once you've conceived a strategic approach for lowering total landed cost, it's time to model it. Spreadsheets are cumbersome, and modeling software is expensive and has a steep learning curve, so outsourcing the development of your model is often your best bet.

When choosing someone to develop the model, look for an expert in supply chain design and operations, not just a techie who knows how to drive the software. You need someone who can create solutions from practical logistics experience.

It's good to run various "what-if" scenarios. Don't simply model a pre-conceived solution and accept the result. If you have a supply source in China, for example, run a model that compares it to a source in the United States. This tests and quantifies the trade-offs between a longer chain that has lower unit costs but greater inventory, and a shorter chain with less inventory but higher unit costs.

It's also good to run sensitivity analyses to determine how robust the model's design is. Test it by modelling transportation costs against oil prices, or a total disruption in your supply chain, such as a port strike. What are your options in those situations?

As you might guess, a model's quality depends on the quantity and quality of the data it is built upon. Models are also time-dependent: the more complex your supply chain, the longer it takes to develop a model. The potential savings, however, are great—typical companies save 6 percent to 12 percent.

Adapting the Model

With a successful model in hand, and continuing focus on the total landed cost, you can put on your tactical hat, and fuss over discrete tactical functions. Work the supply chain backward from the customer, one function at a time—keep in mind that every supply chain process or function you compromise from the model affects other processes, either positively or negatively.

Remember that supply chains are perpetually changing, so the right model today can easily be wrong tomorrow. A new product introduction, a different vendor, increased freight costs—these all impact your total landed cost strategy.

The good news is that a strategy is easier to modify than to create. The model you used to finalize the first approach will still be there to tinker with.