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Rising oil prices drive creative supply chain managers

With the struggle for a more democratic regime in Libya and other North African countries, and renewed debate on nuclear power given recent events in Japan, oil prices have risen in the last couple of months to the highest values since August 2008. A barrel of North Sea Brent has gone up from about US$80 per barrel in March 2010 to about US$110 per barrel today – an increase of nearly 40% in just one year. How does this rapidly increasing oil price affect supply chains and their operations? Should automotive companies just endure this increase in transportation costs, or are there alternatives?

Since the mid-1990s, many automotive companies have focused on lowering operational costs, and in particular on off-shoring and consolidating production capacity. As a result, many OEMs and suppliers set up large plants in countries like China and India because of the low cost of labour and low cost of transporting the finished goods to Europe and the US. Also, just-in-time inventory and continuous replenishment strategies emerged, especially in retail (causing congestion in inner-city areas).

A barrel of North Sea Brent has gone up from about US$80 per barrel in March 2010 to about US$110 per barrel today – an increase of nearly 40% in just one year.

This was all possible due to low oil prices and therefore low transportation cost. With oil prices rising, things become different. A straightforward analysis of changes in Brent oil price versus changes in diesel price shows that a 10% increase in crude oil price will result in an increase in diesel price of 8.7%. The increase of the past year therefore resulted in a 36% diesel price increase, or a €0.12/km (US$0.17/km) cost increase (assuming 3km to 1 litre fuel consumption, current diesel price €1.329/litre). Although labour cost is still the highest cost component in transportation, the relative part of the cost of fuel has risen drastically.

This increase in transportation cost is significant enough to rethink supply chain strategies, especially for makers of products with low profit margins and long product life cycles, such as cars and buses. Higher transportation costs will reduce their profits significantly. So what can they do? Without changing supply chain infrastructure, transportation costs will go down when shipping larger quantities and therefore achieving more economies of scale, but inventory costs will go up. Transportation costs will also decrease when using slower modes of transport; from air to road and from road to rail. This will however increase lead time and inventory. Mathematical modelling can make the trade-off clear and lead to the optimal choice. Using 3rd party logistics providers (3PLs) will potentially reduce cost, because 3PLs have better consolidation possibilities. Last but not least, better utilisation of truck capacity using efficient packaging, load and pallet building capabilities will decrease cost.

Special optimisation models and software, like LoadDesigner, are required to get the best possible truck utilisation. It is not only about stacking the goods as efficiently as possible on the truck; it also requires thinking about the order in which the products will be delivered.

A clear example of this is the improvement achieved by E-Logistics Control (part of Ewals group), which managed to increase truck utilisation by 10%. This was no mean feat, and reminiscent of the game ’3D-Tetris’. Special optimisation models and software, like LoadDesigner, are required to get the best possible truck utilisation. It is not only about stacking the goods as efficiently as possible on the truck; it also requires thinking about the order in which the products will be delivered. Failure to do this will result in completely rearranging the truck load at each stop. The challenge combines routing, packing and stacking.

As transportation costs continue to rise, so interest in the optimisation of the supply chain infrastructure will increase. Reducing the length of the final leg in the supply chain and consolidation of shipments will reduce transportation costs but will require additional and larger warehouses, which implies more stock, hence higher inventory levels and costs. Deciding on the number of locations to add requires finding a balance between the costs of transportation, inventory, handling and warehousing. The best supply chain design can only be found with the use of supply chain infrastructure optimisation models. By using these models, different supply chain designs can be modelled, evaluated and optimised, taking into account not only the costs involved, but also the impact on lead times and inventory levels.

Thus, oil price increases are fuel for thought. Supply chain managers have all kinds of options to deal with oil price-induced cost increases. Operations Research (OR) can assist them, whether considering a complete supply chain redesign, or just making better use of available assets.

The opinions expressed here are those of the author and do not necessarily reflect the positions of Automotive World Ltd.

John Poppelaars is Director of the ORTEC Consulting Group.

ORTEC is one of the largest providers of advanced planning and optimization software solutions and consulting services. The ORTEC Consulting Group is a member of the ORTEC Group and assists companies and organizations to make informed, fact-based decisions based on thorough analysis.

ORTEC’s solutions result in optimized fleet routing and dispatch, vehicle and pallet loading, workforce scheduling, delivery forecasting and network planning. ORTEC provides best-of-breed, custom made and SAP certified and embedded solutions, supported by strategic partnerships. In the area of Advanced Planning Solutions and consulting services, ORTEC has over 1,450 customers worldwide, over 550 employees and offices in Europe, North America, Asia and the Pacific Region.

For more information about the ORTEC Consulting Group – and its consulting services – go to: www.ortec-consulting.com

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