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(Globalization and reaping scale advantages by

centralizing logistics)

The paradox is Globalization.

Word counts excluding front matter, references and appendices is

2500.



Summary

The purpose of this report is to highlight achieving economies of scale by centralising

logistics, specifically, by centralising distribution system. It also shows the way of

moving from decentralising to centralising distribution system as well as the benefits

of this decision. There are different ways for centralising distribution system in which

global companies adapt, such as direct system, multi-country warehouses, and

Consolidation Centres. Both centralised and decentralised distribution systems will be

highlighted to show how a company able to reap scale advantages more in a

centralised than the decentralised one. ITT Flygt Company is utilized in as a case

study to show the benefits in which this company achieves when it shifted from a

decentralised to a centralised distribution system.

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Table of content

1 Introduction Page 4

2 The concept of logistical system Page 5

3 Centralized distribution Page 6

4 Global distribution options Page 9

4.1 physical distribution systems Page 9

4.1.1 The direct system Page 94.1.2 Classical system Page 10

4.1.3 Transit system Page 10

4.1.4 Multi-country warehouse Page 10

4.2 Time-based and spatial consolidation Page 10

4.2.1 Cross docking Page 11

4.2.2 Merge-in-transit Page 11

4.2.3 Manufacturing Consolidation Centre Page 12 4.2.4 Mega Consolidation Centre Page 12

4.2.5 Fresh Consolidation Centre Page 13

5 Case study (ITT Flygt) Page 14

6 Conclusion Page 17

References Page 18

Appendices Page 20

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1 Introduction

De Wit, and Meyer, (2005) argue that cross-border synergy is important aspect in

achieving competitive advantage. One of the important activities for cross-border

synergy is by to reap advantages by centralising activities, such as logistics, and

production. Centralisation is achieved when those activities are physically combined

together, which is called as sharing value-adding activities. The focus on this report is

on centralisation of logistical activities, specifically distribution system, in global

firms as a way to achieve economies of scale. The report will analyze the benefits of

centralising distributions system in which companies achieve compared to the

decentralized one, and different ways for centralizing logistics which companies areadopting. Lastly, ITT Flygt Company is utilized as a case study which identifies how

it’s now able to reap scale advantages from shifting distribution system from

decentralised to centralised one.

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2 The concept of logistical system

Logistics has been identified by the Council of Supply Chain Management

Professionals (CSCMP), (2005), p63, cited by Kohn, (2005), p.12 as:

'' Logistics is that part of the supply chain process that plans, implements, and

controls the efficient, effective forward and reverse the flow and storage of goods,

services, and related to information between the points of origin and the point of

consumption in order to meet customers' requirements.''

From this definition the main conclusion is logistics consists of a range of activities

that need to be managed altogether to achieve customers' satisfaction and to meetorganisational goals (Christopher, 1986, cited by Kohn, 2005).

Logistics includes managing the flow of physical material , information management,

in particular managing inventory, warehouses, distribution, different methods for

products' distribution and transportation, logistical network design, and a third party

logistics provider (CSCMP, 2005, cited by Kohn, 2005).

According to Christopher, (1998), cited by Kohn, (2005), the logistics system consists

of three elements: Procurement, operations, and distribution.

The focus of this report will be on distribution.

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3 Centralized distribution

A distribution system includes a range of activities, such as moving goods or

materials, warehousing, controlling inventory process, packaging, arranging

locations, managing data collection, moving and handling materials, and network

communication. It also includes moving goods from the manufacturer to the

customer; and returning them to the manufacturer (CSCMP, 2005, P. 36, cited by

Kohn, 2005). To achieve competitive advantage, many global firms are trying to

be close to customers; however, this argument has two sided. On one hand, having

warehouses in different locations enables firms to have a fast and reliable response

to customers' demands. However, having a decentralised logistical systemincreases the cost of warehouses equipments, paying wages for employees, and

increasing the total costs for the storage of goods in shelves for each warehouse

(Coyle, Bardi, and Langley, 1988. cited by Kohn, 2005).

According to Abrahamsson, (1992), cited by Kohn, (2005), because of advances

in information technology it's now easy for firms to change the way of their

distribution from a decentralised to a centralised system. This is a shift to Time

Based Distribution (TBD), rather than a geographical system (figure 9). The

theories behind this approach are theories of economies of scale and scope.

Economies of scale describes the way of reducing cost by increasing scale

(Pratten, 1975, cited by Kohn, 2005); whereas economies of scope identifies a

new way for cost reduction by aggregating activities rather than separating them (

Panzer and Willig, 1981, cited by cited by Kohn, 2005).

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(Adapted from Kohn, 2005)

Abbrahamsson, (1992); Abbrahamsson, and Brege, (1995) cited by Kohn, (2005)

argue that to achieve economies of scale the distribution system has to be

centralized in to the logistical structure, with the latter to include different

activities, such as operations system, and logistics operations; and also should be

treated as a separate function. Centralising distribution enables companies to

sustaining price-based advantage by lowering the cost of operations. This is

achieved by holding a higher volume of inventory than competitors. For example,

Johnson, Scholes, and Whittington, (2008) argue that the latter can be achieved

when a company centralises activities such as distribution to decrease total

distribution channel costs, which is in line with theories of economies of scale.

Abrahamsson, (1992), cited by Kohn, (2005) finds two different

advantages a firm can reap from having a centralised distribution system.

• The logistical advantages:

- Lowering the cost of warehouses. Running one warehouse

lowers the total cost of warehouses activities compared to having

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4 Global distribution options

Becker, Verdujin, and Kuipers, (2003) divide the distribution options into the

following two categories:

4.1 physical distribution systems: Picard, (1982) cited by Becker et al, (2003) argue

that any global companies have to make a number of decisions before adapting an

appropriate network. Those decisions include the physical distribution systems. Both

centralised and decentralised distribution systems will be discussed to show how they

achieve economies of scale.

4.1.1 The direct system: in this option products are sent directly from the

manufacturer to the final customer. This is costly, as it requires fast and reliable

deliveries (figure 4). In addition, products’ final touches, such as labelling, packaging

and quality checks are made at the manufacturer. Li, (2008) argues the most important

advantage from this system is all inventories are centralised at the manufacturer, Dell

adapts this system.

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Figure 4: Manufacturer storage with direct shipping (Chopra, and Meindl,

(2007) adapted from Li, (2008).

In addition, Chopra, (2003) argues it enables the manufacturer to benefits from low

inventories even more by postponing products until the order arrives. The

manufacturer is then able to change and modify products to meet customers’

requirements (Van Hoek, 1998), which leads to inventory reduction. Furthermore, this

approach enables all supply chain to save the cost of warehouses as all inventories arekept at the manufacturer. However, drop shipping, as this system is called by Chopra,

(2003), has drawbacks, as it's dependant on a good information system that links the

retailer with manufacturer to place orders. In addition, it takes a long time to deliver

products from manufacturer to customers. Furthermore, it has a high transportation

cost, as products travel through a long distance to reach their final destiny.

4.1.2 Classical system: Becker, et al, (2003) argue in this system the manufacturer is

on one continent, and the warehouses are in another continent close to customers.

Both are related by ports. In case of ocean shipments, they are mainly preferred

because they are cheaper than air cargo. In addition, this option allows exploitation of

economies of scale, as it allows to aggregating shipments.

4.1.3 Transit system: this system is similar to the one above, as the manufacturer is

placed in one continent and connected by satellite warehouses, which are located in

another continent to be close to the market, and both are linked by ports (Becker, et al,

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2003). The biggest advantage of this option is that inventory level is kept to minimum

by keeping stocks at the manufacturer. However, the cost of transportation is high

because aggregating shipments are less likely to occur and when demand for products

is increased, responding to demands by satellite warehouse won’t be easier.

Manufacturer spare parts are utilising this option.

4.1.4 Multi-country warehouse: Some global companies have a central warehouse

serves all countries. Products are distributed to the central warehouse via sea. The

transportation in this option is slow and aggregated, then they will be transferred

either direct to the customer, or to other midpoints. The former is used as a transit

system, or as a stock location, as in the classical system.

4.2 Time-based and spatial consolidation: According to Becker et al, (2003), this

strategy consolidates achieving economies of scale and time reduction, by co-

operation between manufacturers, with both logistical activities providers and

retailers. This concept includes the following options:

4.2.3 Manufacturing Consolidation Centre: this centre is based on a combination of

manufacturers that require similar logistical activities (ATO-DLO, 2001, cited by

Becker et al, 2003). Products are distributed in one delivery which enables companies

to deliver in a regular manner one full truck shipment to the distribution centres.

Those products then are distributed differently according to the retailers’ plans. A

manufacturer in this option is looking for a partner who shares similar customers, or a

partner who has similar logistical barriers, to reap synergy returns. Frozen food

manufacturers are adapting this option.

4.2.4 Mega Consolidation Centre refers to a centre where the manufacturer and

retailer aggregate products’ transportation and warehouses that requires similar

logistical system (ATO-DLO, 2001, cited by Becker et al. 2003). Those centres

expanded Manufacturing Consolidation Centre duties by including the retailers’

distribution centres. Frozen food, for example, is processed via this way.

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4.2.5 Fresh Consolidation Centre (FCC): This centre combines fresh merchandise and

is located close to retailers. It aggregates those products according to retailers’

requirements. ATO-DLO, (2001) cited by Becker et al. (2003) argue these centres aim

at fast and reliable deliveries. Farming products utilize this option. Transportation in

this option is made direct from the manufacturer to the FCC. In addition, this option

requires regular deliveries.

From those options it can be concluded that centralised systems allow exploitation of

economies of scale by reducing transportation costs more than can be achieved in

decentralised systems.

5 Case study (ITT Flygt)

This case study adopted from Kohn, (2005). For more detail, see appendix 3.

ITT Flygt is a glass mould manufacturer in Sweden, which has now become a

successful global company producing pumps. Until 1999, the ITT Flygt

distribution system was decentralised, as holding a huge number of stocks at each

local store around the world. The reason was because before the development of

European Union, it was difficult to transfer products across the world, while

sharing one pumps supplier, Lindas. The latter sent products to each country

according to their requirements. The problem was the long time takes between

placing the order and delivery time. In addition, express deliveries were another

problem for some countries, UK for example. This option was used to ship goods

to customers in emergency time, and also it was used by Lindas to deliver

products to the UK. From the UK perspective, this transport was slow and didn’t

meet customers’ requirements. Therefore, it was hard for the company to

standardise products as each local company worked autonomously. In addition,

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local inventory costs were high because of the time between placing an order and

receiving it. Furthermore, because each local company acted separately, there

were a huge number of carriers engaged to deliver.

As a result, ITT Flygt realised the importance of changing its distribution system

to a centralised system, which provides a standard products across the world. The

final decision was to replace eight warehouses with a central one, which aims at

holding a wide variety of products and stocking them in case of increase demand.

Metz, in France was the location where the company decided to have its central

warehouse (Figure 7).

Figure 7: Depiction of generic distribution flows in ITT Flygt’s centralised

distribution system (adapted from Kohn, 2005).

Another feature ITT Flygt had to look at was deceasing the number of carriers to

only two, namely DHL and Wincanton, which will have an impact on cost

reduction.

Metz attached a new system, SDC Metz, to ensure that time and type of order for

each company is appended to this system. SDC Metz on a daily bases has lorries

ship goods to Wincanton then from there to different parts of the world. Packaging

and loading were another area ITT Flygt has to look at to ensure that they are

operated and shipped effectively to develop the fill-rate between Lindas and Metz.

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As a result, the flow of goods between Lindas and Metz was improved between

2003 and 2004 (appendix 1).

Implementing a centralised system has allowed ITT Flygt to reap scale

advantages, by reducing cost relating to logistics. This includes transportation

costs for many reasons. For example, the ability to negotiate for the best transport

price for those services is decided centrally. In addition, the total cost of express

and emergency deliveries decreased.

Furthermore, this system enables SDC Metz to raise its service level in 2003 to

95% (appendix 2).

6 Conclusion

Centralising logistics is becoming a predominant trend amongst global companies

for many reasons. The most important reason is achieving economies of scale.

This is achieved by lowering the cost of warehouses, as running one warehouse

leads to lowering the total cost of warehouse activities compared to having

multiple warehouses. In addition, having a central warehouse leads to a decrease

in the number of inventories and the cost of transportation is fixed. Logistical

activities consist of procurement, operations, and distribution. However, the focus

on this report was of centralising distribution as a way to reap scale advantages.

There are different ways for centralising distribution, such as direct system, multi-

country warehouse, and Consolidation Centres. Although those systems have

disadvantages, they proved to reap economies of scale advantages to a great extent

than in decentralised systems. ITT Flygt was an example of a decentralised

system, which led to major consequences, such as making it was difficult to

standardise products as each local company worked autonomously. In addition,

local inventory costs were high because of the time taken between placing an

order and receiving it. Furthermore, because each local company acted separately,

there were a huge number of carriers engaged to deliver. However, implanting a

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centralised system has allowed ITT Flygt to reap scale advantages, by reducing

cost relating to logistics including transportation cost (Kohn, 2005).

References

- Barnes, D. Operations Management. London: Thomson Learning,

(2008).

- Becker, J.F.F, Verduijn, T.M., and Kuipers, B. (2003). Innovative

global logistics concepts. Consolidation centres and goods flows of global

players. No. 03 3N 017 32091. Netherland Organisation. TNO.

- Chopra, S. Designing the distribution network in a supply chain.Transportation Research Part E 39, 2003: 123-140.

- Coulter, M. Strategic Management in Action. Upper Saddle River:

Pearson Education, (2008).

- De Wit, B. and Meyer, R. Strategy Synthesis. Resolving Strategy

Paradoxes to Create Competitive Advantage. London: South-Western,

2005.

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- Droge, C. and Germain, R. The Impact of the Centralized Structuring

of Logistical Activities on Span of Control, Formalization and

Performance. Journal of the Academy of Marketing Science. Vol.17, No 1,

1989: Page 83-89.

- Johnson, G., Scholes, K. and Whittington, R. Exploring Corporate

Strategy. Harlow: Pearson Education, 2008.

- Kohn, C., (2005). Centralization of Distribution Systems anditsEnvironmental Effects. . Ph.D. International Graduate School of

Management and Industrial Engineering: IMIE.

- Li, C., (2008). Framework for Selection of Distribution Strategies.

Master Dissertation. Massachusetts Institute of Technology.

- Van Hoek, R. Reconfiguring Logistics systems through postponement

strategies. Journal of Business Logistics. Vol. 19, No.1, 1998: Page 33-53.

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Appendices

Appendix 1: Fill-rate comparison between 2003 and 2004 for transfers between

Lindas and sales companies/final customer . Adapted from adapted from Kohn,(2005).

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Appendix 2: Monthly delivery performance for SDC Metz 2003 (adapted from

Kohn, 2005).

Appendix 3: ITT Flygt (adapted from Kohn, 2005)3.1.1.Company history

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Sweden is well known for its many glassworks and Peter Alfred Stenberg specialised inproducingironmoulds and equipment for the many surrounding companies. Just over a decadelater thecompany was restructured and given the new name Lindهs Gjuteri & Formfabriks AB(LindهsFoundry & Mould Factory) and a few years later Peter Alfred Stenberg transferred the

responsibility for the factory to his children.

Later on, in 1929, an engineer from Stockholm named Hilding Flygt advertised in thedailynewspaper in order to find a company that was able to manufacture the products hiscompanydeveloped, namely pumps. The Stenberg brothers responded to the advert and thecooperationbetween Hilding Flygt and the Stenbergs in Lindهs saw the light. About a year later thecompanywas able to introduce its first pump, the “universal pump” (see Figure 20).

Figure 20: The company's first pump, the "universal pump"

Almost two decades later, in 1947, Hilding Flygt decided to retire and AB FlygtsPumpar wassold to the Stenberg brothers in Lindهs. In the same year the company introduced theworld’sfirst submersible pump thanks to the engineering knowledge of Sixten Englesson, anemployee of the company. Over the subsequent years the company introduced new pumps,started an exportcompany, and established foreign subsidiaries. In 1968 the American multinationalcompanyInternational Telephone & Telegraph Corporation, better known as ITT, acquired thecompanythrough an exchange of shares, and the following decade the Lindهs plant grewtremendously asan expanding range of products were introduced. Later on, in 1991, the companyname waschanged to ITT Flygt AB, a name that the company holds to this day.

Today ITT Flygt is the world’s largest manufacturer of submersible pumps and mixers,

and isrenowned for producing efficient and versatile products of the highest quality. ITTFlygt’s visionis to be recognised as the leading supplier of solutions and services in fluid handlingwith

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submersible products worldwide. In trying to live up to this reputation as a marketinnovator thecompany has recently released the N-pump, which promises to revolutionisesubmersiblepumping, much in the same manner as the first submersible pump did just over half acenturyago.

3.1.2 Facts and figuresWith its 44 wholly or partly owned sales offices, representation in over 130 countriesaround theworld, production plants in Sweden, Germany, the Netherlands, Argentina, and China,anddistribution centres in Sweden and France, ITT Flygt can truly be considered aninternationalcompany. The company has over 4,000 employees, of which over 2,500 are stationedoutside of Sweden. The corporate headquarter is located in Stockholm, as well as thedepartments of Research & Development, Marketing, Flygt International, and the Swedish salescompany. Thelargest production plant is located in Lindهs, where the company has its roots, and in2003approximately 78,000 out of the company’s total production of 130,000 pumps were

manufactured here, as well as 8,500 out of 8,600 mixers. The departments of Finance,

Quality,and Shipping are also located in Lindهs; whereas Purchasing, Human Resources, andIT/IS arefunctions that are divided between Lindهs and Stockholm. Figure 21 below shows an

organisational chart of the ITT Flygt Group.

ITT Flygt GroupCEO

Manufacturing

Product Management Operations Product Management Finance

Information Technology,Bus. Proc. Development,Quality & ESH

Human Resources &Corporate Communication

Value Based Six Sigma

Business Development

Group Purchasing,Logistics & ProductionEngineering

SDC Metz

Flygt Werk

Lindهs Plant

Manufacturing &Distribution

Research &Development

Technical Support

Research &Development – otherunits

Region Asia Pacific

Region Americas

Region Europe

BU – Industry

BU – Construction &MiningMarket Communication

BU – Public Utiliy

Figure 21: Organisational chart of the ITT Flygt Group

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Today, ITT Flygt is the flagship of the ITT Fluid Technology division, which is a business

segment of ITT Industries where all companies in the group are active in developingfluidsystems and solutions in order to move and control water and other fluids. Fluid

Technology isone of four business areas, where the other three areas include ElectronicComponents, DefenseElectronics & Services, and Motion & Flow Control, and represents 40 % of total salesfor ITTIndustries. The corporate headquarter of ITT Industries is located in White Plains, New

Yorkand the company employs about 38,000 people all over the world. It is noted on theNew YorkStock Exchange as well as on the stock exchanges US Midwest, US Pacific, London,Paris, andFrankfurt.

3.1.3 The market

In 2003 ITT Flygt had a turnover of approximately US$ 763 million, where theEuropean and USmarkets make up for almost 90 % of total revenues (see Figure 22). Just over 50 % of these salescan be attributed to the waste-water segment, with industry and construction makingup otherlarge segments, and 20 % and 18 % of sales come from these respective segments.

2% 9%

3%

28%58%

Africa and the Middle East

Asia and the Pacific Ocean

South America

North America

Europe

Figure 22: Sales per region for ITT Flygt

ITT Flygt is considered to be a premium brand on the submersible pump market andthe pumpsare used in various settings and environments. For instance they are used to pumpwaste-water inthe London Docklands, to drain mines in South Africa from water, or to create man-madesurfing waves in Texas. Just as with most other industries ITT Flygt has a number of companieswith whom it needs to compete over market shares and currently some of the largercompetitorsinclude Grundfos and ABS Pumps.

Earlier ITT Flygt considered the market in a somewhat narrow manner, or rather the

market wasdefined as just selling pumps, and with this view the company considered itself tohave a marketshare of approximately 25 %. Today, the company defines the market in a broaderfashion and

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the goal is not only to supply a submersible pump, but instead to supply a completesystemincluding installation and other services. When the market is defined by using thesecriteria, thenITT Flygt instead considers its market share to be approximately 5-10 %. However, thecompanyhas presented an offensive strategy for the coming years, a strategy where thecompany shallgrow substantially over the coming years and increase its overall market share. Thisexpansionshall be achieved through extensive acquisitions as well as increases in sales on

markets outside of Europe and the U.S.

3.1.4 The pump

Even though many of the pumps ITT Flygt in fact sell look and operate in a similarfashion, thecompany does not have a standard or pre-specified product that the customer canpick out froma catalogue in the same manner as they could do if they bought something from Elfa orIKEA. This is because a product can come in more or less a million different configurations,sincecables, voltage for motors, or material for the sealing jointing and the like can varydepending onthe preference of the customer in question. Figure 23 below illustrates typical

products of ITTFlygt.

Figure 23: Typical ITT Flygt pumps

Until the 1960s ITT Flygt was a rather small company and it was not that difficult tospecify whatcomponents each of the products were to have as they were ordered, since volumeswere not thatlarge and therefore the workload was manageable. Sales representatives went outinto the fieldand sold pumps to the customers through the use of brochures, technicalspecifications, effectcurves etcetera and could quite easily specify the characteristics that described acertain product. These were then transferred to the factory where personnel translated these ordersinto specificarticles so that the customers received the pump they actually requested. These listscouldcontain, depending on the type of pump, between 50 and 100 articles.

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When ITT Flygt started expanding on new markets and the volumes started to grow,this way of working was no longer feasible since this would be too time consuming. Therefore, thecompanyin the 1970s introduced an identity system, a system that had the purpose of makingit possible toidentify all objects, e.g. single parts, components, or a complete unique product. Thissystem canbe seen described as an “identity pyramid” and Figure 24 below gives an example of what this maylook like.

CP 3085

3085.182

3085.182-010

3085.182-0025

3085.182-010-151-232-300-414-599-699-700-805-999

3085.182-9511235

82 40 59, 397 75 00

Sales denomination

Product code

Module

Product number

Delivery code (module combination)

Serial number

Parts

Figure 24: Example of the ITT Flygt "Identity pyramid"

When a customer today sees a pump, the sales representative sees a product codeaccording tothe identity rules that the company have decided upon in the technical administrationsystem. The order is then handled by the order personnel, who for that particular productgroup matchcustomer requirements with the matching articles in each of the module groups, e.g.motormodule group, cable group, or pump wheel group. The final product then is actually a

configuration of various modules. This way of describing the products has turned outto be avery efficient way of describing all the parts, components, and modules, and it hasbecome clearand easy to see all available product combinations.

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