Currently 80% of 3PLs in China are losing money due to price competition. Based on ST-Anda Logistics estimates of logistics cost (transportation & warehouse excluding inventory carrying cost) as a percent of total revenues in various industries are illustrated in Table 5.1.
Table 5.1: Logistics costs as a percentage of total revenues for various industries. (Source: ST-Anda Logistics)
Case Study: China Spirits40 Bidding Year
Established by a well-known overseas Chinese merchant with a long history in the business years, China Spirits is one of the first industrialized wineries in China and one of Asia’s largest winemaking enterprises. In 1997, China Spirits arouse out of the merger of several subsidiaries and was listed on the Shenzhen Stock Exchange. The company mainly produces brandy, wine, champagne and health wines.
There are few barriers to entry in the wine industry and so with time competition has intensified. By 2000, China Spirits recognized that although its revenues continued to rise, it was losing market share. In response, top management encouraged the sales department to improve sales in the low season. This coincided with the next around of transportation bidding, and the logistics manager Peter invited a 3PL to participate. The 3PL’s investigation of China Spirits’ operations and distribution system revealed that different Vice Presidents managed different departments with little coordination. Peter, for example, was especially sensitive to the fact that sales often accepted small orders under unfavorable delivery terms.
Currently China Spirits maintains forward storage in all 17 primary sales regions from north to south. In each location sales leases space in a warehouse and pays all storage costs. The company centrally manages the maximum inventory budget in each location as illustrated in Table B1 and ensures that no location exceeds its maximum allowed inventory level. Additionally packaging differs from region to region so sales cannot sell products across regions.
China Spirits sells more than 40,000 tons per year and the annual total transportation costs are around 30 million RMB. Top management has asked Peter to reduce total transportation costs by 10% next year. The evaluation of the bidding is solely based on the transportation rate charged by the fleet, which is fixed for the entire year and does not depend order size. Winners are allocated different regions. Once a contract is signed, the winner should submit its guarantee capital, which will not be refunded if it breaks the contract.
Maximum inventory cost (million RMBYuan)
Cities in north east
Cities in south
Cities in mid China
China Spirits Logistics Challenges
Experts in the 3PL described Peter’s complaints one day:
An order of 10 boxes of wine has been shipped out eight days ago and has not arrived in Beijing yet. Normally it takes 2 or 3 days. (It is obvious that the driver defers the shipment for consolidation because such a small order cannot be justified at the agreed transportation rate.)
He received a call from Guangzhou Port who urged him to collect the containers that have been sitting at the port for six days. Usually Containers are allowed to remain three days free of charge. Sales in Guangzhou was reluctant to collect them.
To remain within the allowed inventory limits, sales in each region tend to place small frequent orders and frequently complain that the orders do not arrive on time.
Regions in the south, east and north of China are allocated to different fleets. The different order sizes and frequencies in those regions incur different transportation costs. After one year’s operation, some fleets declined to participate in the bidding because they were hard pressed to make any money.
Peter will have dinner with a local ocean carrier to help ensure that products shipped out on schedule for the important Mid-Autumn Festival and National Day seasons.
Poor forecasts and the prohibition against selling across regions mean that some products sit in storage in market regions for more than one year. This further complicates sales challenge of keeping stocked with fast moving items while respecting the inventory limits.
If Peter strictly enforces the bidding contract, no fleet will be refunded its guarantee capital at the end of the year. But then, who will ship goods for the company next year?
Lean Distribution — Consolidation is the key
The 3PL recommends China Spirits stop bidding and modify sales regulations to enhance distribution efficiency. They suggest that three distribution centers be stocked with respect to transportation mode, market demand, geographical factors and service levels. The solution is based on the following strategy:
Service level is evaluated in time-windows and classified according to regional sales volumes;
Inventory pooling is based on sales revenue of products under the principal of ABC;
Facility location needs to be close to market regarding trade-off between transportation cost and inventory cost constrained by service level;
As illustrated in Figure B1, the three distribution centers recommended are: Tianjin, Shanghai and Guangzhou to serve regions in the North, East and South respectively. The 3PL sets a very high service level of 2 days delivery in these regions considering the associated high contribution to the annual revenue. Because regions in the west and northeast can only generate 4% and 6% of revenue respectively, the 3PL does not set a high service level in terms of transportation mode and delivery time.
Inventory level is determined under ABC principle. Generally speaking, Dry Red Wine is in A class, Health Wine, Brandy and Common Red Wine in B class, and Champagne in C class. In terms of possible sales changing in the near future, a dynamic review of inventory level is necessary. For example, sales of Health Wine, a new fashion in China, are booming in the south and east, and so may quickly move to A class.
Tianjian and Shanghai are replenished daily in the peak season and week delivery in the low season. Once replenished, products are sorted and distributed simultaneously, and therefore a high service level is ensured without high inventory costs. The mixed-order of replenishment initiated from each DC is determined by the associated inventory level and capacity of TL shipment.
Total inventory costs can be reduced by at least 30% without reducing service levels.
Eliminate the prohibition against sales across regions and promote inventory pooling.
Transportation costs are already very low. Under the new system, distribution costs in the second stage from DC to retail outlets will increase more than expected as the orders become smaller and delivery distances shorter.
The target 10% reduction in annual transportation cost neither be justified nor achieved.