# Presentation: 098155

## The Impact of Oil Price on Supply Chain Strategies

*The Impact of Oil Price on Supply Chain Strategies*

- David Simchi-Levi
- E-mail: dslevi@mit.edu

**Professor, Massachusetts Institute of Technology**

**Chief Science Officer **
**ILOG **

## Traditional Business Strategies

**Traditional Business Strategies**

**Lean Manufacturing**
**Outsourcing and offshoring**
**JIT**
**Quick and frequent deliveries**

**These strategies are based on assumptions of **
** ****Cheap oil price**
** ****Low labor cost in developing countries****   **

## Increase in Logistics Costs

**Increase in Logistics Costs**

**Rising energy prices**
**Rail capacity pressure**
**Truck driver shortage**
**Security requirements**

**15% increase**

## Total US Logistics Costs 1984 to 2007 ($ Billions)

**Total US Logistics Costs 1984 to 2007 ($ Billions)**

**Source: 19****th**** Annual Logistics Report**

**52%**

**Transportation**

**Admin**

**47%**

**62%**

**Total Cost**

**Inventory**

## Impact of Oil Price on...

**Impact of Oil Price on...**

**Transportation Costs**
**Network Strategies**
**Transportation Strategies**
**Supply Chain Strategies**

## US Diesel  and Crude Oil Prices over time

**US Diesel  and Crude Oil Prices over time**

## Relationship between Crude Oil price and Diesel Fuel Price 

**Trend Line Model  **
**Diesel Retail Price(Cents per Gallon) = 2.38515*Crude Oil Price($/barrel) + 132.292**

## Implications on crude oil price to transportation rates

**Given the relationship in the previous slide, we see that a $10/barrel increase in crude oil will result in ~$0.24/gallon increase in diesel fuel**
**Standard fuel surcharge methodology is to increase surcharge $0.01/mile for every $0.06 increase in diesel fuel**
**We conclude that for every $10 increase per barrel of crude oil price, we have an additional $0.04/mile increase in transportation rates.**

## Impact of Oil Price on...

**Impact of Oil Price on...**

**Transportation Costs**
**Network Strategies**
**Transportation Strategies**
**Supply Chain Strategies**

## Impact of Oil Price on Network Strategy

**Impact of Oil Price on Network Strategy**

**Trading off oil price for...**
**Inventory costs**
**Facility costs**
**Manufacturing costs**

## Manufacturer of consumer packaged goods

**Manufacturing is possible in three locations:**
**Philadelphia- Highest production cost**
**Omaha- **
**Juarez, Mexico- Lowest production cost**
**60 potential DC locations**
**888 aggregated customers**
**Inbound transportation uses commercial TL carriers**
**TL averages 40,000 lbs/shipment**
**Outbound transportation uses a private fleet **
**Private fleet averages 20,000 lbs/shipment**

**Case Study 1: Oil Prices and the Logistics Network**

## Case Study - Objectives

**Determine the best number and location of distribution centers, as well assignment of customers to DC’s.**
**Determine the best allocation of production to their manufacturing locations.**
**Understand how the optimal network would change as oil prices fluctuate**
**Roughly 25% of the supply chain costs are in transportation**

## Network Visualization

**Network Visualization**

## Discussion of Tradeoffs

**As crude oil price increases, transportation costs become more important relative to production, inventory and facility fixed costs. **
**Oil price vs. inventory carrying and facility costs**
**Additional DCs are more attractive**
**As outbound transportation becomes more expensive, it becomes increasing important to minimize the distance of the final leg.**
**Oil price vs. production costs**
**Production moves nearer to demand  **
**Cheaper manufacturing in Mexico is offset by higher transportation costs.**

## Oil price vs. inventory carrying and facility costs

**Oil price vs. inventory carrying and facility costs**

**Moving from $125/ barrel to $150/ barrel changes the optimal number of DC’s from 5 to 7. In particular, you can think of Las Vegas being replaced by Los Angeles, Albuquerque, and Portland.**

**$75/ barrel **

**$200/ barrel **

**The Tipping Point**

## Oil price vs. production costs

**Oil price vs. production costs**

**$75/ barrel **

**$200/ barrel **

## Total Cost Comparison

**3% increase in total cost **
**as the price of a barrel**
**increases from  $100 to $150**

## Impact of Oil Price on...

**Impact of Oil Price on...**

**Transportation Costs**
**Network Strategies**
**Transportation Strategies**
**Supply Chain Strategies**

## Changes in Transportation Strategy

**From JIT delivery to better utilization of transportation capacity**
**Larger lot sizes shipped less frequently**
**Efficient packaging to improve truck utilization**
**From quick delivery to cheaper and sometimes slower transportation modes**
**From air to ground**
**From trucking to rail **
**From dedicated to shared resources**
**3****rd**** party carriers **
**Consolidated warehouses**

## Changes in transportation strategy: Examples

**Changes in transportation strategy: Examples**

**In 2007, S.C. Johnson’ truck utilization project saved the firm “$1.6 million and cut fuel use by 168,000 gallons.” **
**The firm found that mixing loads of Winded glass cleaner and Ziploc bag, which used to be packed in separate loads, better utilizes truck capacity**
**Multiple manufacturers store their products in ES3’ giant warehouse located in York Pennsylvania where truck loads are built and shipped to retailer’s distribution centers.**
**An important benefit of the consolidated warehouse is reduction in transportation costs**

## Impact of Oil Price on...

**Impact of Oil Price on...**

**Transportation Costs**
**Network Strategies**
**Transportation Strategies**
**Supply Chain Strategies**

## Changes in Supply Chain Strategy

**More Inventory**
**Due to EOS and more DCs**
**Emphasize on better service**
**To reduce expediting costs**
**Less offshoring**
**To reduce total landed costs**

## Sharp moves from offshoring to nearshoring

**Sharp moves from offshoring to nearshoring**

**TV manufacturer Sharp has recently started moving manufacturing facilities from Asia to Mexico to serve customers in North and South America. **
**This is driven by the need to keep shipping costs low and time to market short. **
**Indeed, price of flat TV typically falls fast and thus reducing shipping time from about 40 days, when flat TVs were produced in Asia, to seven days makes a big impact on bottom line.**

## When to Move from Offshoring to Inshoring? -- Product Characteristics

** **

**III**

**I**

**II**

**Cost of Moving Infrastructure**

**L****	****	****	****	****   H**

**H**
**L**

**Transportation Impact**

**Inshoring**
**Manufacturing**
**or**
**Assembly**
**(TV, Refrigerators, **
**Appliances, Car**
**Parts, Furniture)**

**Inshoring**
**(Footwear, Toys)**

**Offshoring**
**(Mobile Phone, PC)**

## Toy manufacturer is moving plants near demand

**Toy manufacturer is moving plants near demand**

**Steiff, a privately owned German manufacturing company of toys was part of the global outsourcing trend when it moved around 20% of production to low cost countries. **
**The objective was to cut cost and compete on price. **
**Recently, this toy manufacturer started moving production back to Germany, Portugal and Tunisia.**
**The reasons: quality problems together with high transportation costs associated with manufacturing far from the key markets**

## Drivers of Moving from Offshoring to Inshoring  

**Drivers of Moving from Offshoring to Inshoring****  **

**Oil Price**
**Labor Cost**
**The value of the dollar**

**The Average Annual Wage Increase between 2003 and 2008**
**in different Countries**

**Mexico**

**Asia**

**US**

**Slope= $ per pound**

**A**

**B**

**C**

**Slope= $ per pound**

**I**

**II**

**When to Move from Offshoring to Inshoring****  **

## Case Study 2: Sourcing Strategies

**A large floor covering manufacturer**
**Hardwood, Ceramic Tile, **
**Carpet, Laminate**

**Challenge**
**Understand how *****increasing labor****** *****and *****transportation costs***** across the globe are causing previous sourcing decisions to be altered**

## Sourcing Parameters

**37,000**** SKUs**
**Large range of Production Costs **
**$0.01 to $300 per unit if production is in the US**
**Large Range of Weights**
**0.01 to 5,000 pounds per unit**
**Manufacturing options**
**US –Atlanta; Mexico – Monterey; China- Shanghai **
**Combination of transport modes**
**Ocean; Rail; Truck Load**

## Sourcing Analysis - 2008

**Mexico**

**US**

**China**

## Costs increase between 2003 & 2008

**Labor Costs**
**US****	****	**** ↑   15 %**
**Mexico****	****	**** ↑   23 %**
**China ****	****	**** ↑ 144 %**
**Transportation Costs**
**Ocean Freight****	****↑  100 %**
**TL/Rail****	****	****↑    25 %**
**Good estimate of the increase in rail and TL costs**
**Conservative estimate of the increase in ocean costs**

## Sourcing Strategies: 2003 and 2008

**Sourcing Strategies: 2003 and 2008**

## Your Turn!

**Your Turn!**

**How to contact me:**
**David Simchi-Levi****dslevi@mit.edu**