Aerospace Sector

Annex I: Methodology

SCM & Logistics Costs Methodology

Every company measures its costs related to marketing, human resources, research and development, etc. Interestingly, very few know how much their logistics costs really are. The last decade saw a growth in interest for concepts such as JIT, Lean manufacturing and Efficient Consumer Response, all of which, in addition with the globalization of the supply chains, brought the importance of Logistics and Supply Chain Management (SCM) from an operational status, often to a strategic status for the company and its partners.

It is for this reason that Supply Chain & Logistics Canada’s (SCL) Research Committee and Industry Canada have partnered with Jacobson Consulting to launch a logistics cost methodology research initiative. By combining the industry know-how of SCL with the supply chain research experience of Industry Canada and the economical modeling specific expertise of Paul Jacobson, a former director at Infometrica, the partners have developed an optimal research team for this initiative.

One of the main sources of logistics costs’ data available until now is the Annual State of Logistics Report, published in the U.S., which is sponsored by the Council of Supply Chain Management Professionals (CSCMP). This report provides annual data on the cost of the U.S. business logistics system in relation to their Gross Domestic Product (GDP). The data provided goes back to 1984 and is mainly available on a macro level, with categories available such as Inventory Carrying Costs, Transportation Costs and Administrative Costs, but does not look at the sector-level data.

It is important for a company to understand the nature and the costs of its logistics and SCM operations. Furthermore, companies should be able to access that type of information on each industrial sector for comparison purposes. Comparing the information to GDP is essential to understanding the importance of logistics on a given sector, while comparing the information to the Gross margin allows companies to benchmark their logistics and SCM costs to their sector, their partners and their competitors.

• Gross margin =  total operating revenue - cost of goods sold
  
  
• Total operating revenue = sales of goods purchased for resale + commission revenue + sales of goods produced + repair and maintenance revenue + revenue from rental and leasing + other operating revenue.
  
  
• Cost of goods sold = Opening inventory +  Purchases - Closing inventory.

Here, the research initiative will focus on providing sector level information of logistics and SCM costs that occur internally through firms (such as in the manufacturing, wholesale and retail sectors), as well as evaluating supply chain’s functions that are outsourced by sectors, and their relative inventory carrying costs. By combining these three categories, individual firms will have the opportunity to have a global view of supply chain management costs by sectors and of the outsourcing trends, thus allowing them to benchmark themselves to their competitors, partners and other sectors in Canada and in the U.S..

SCM and logistics costs can be broken down in three separate, but complementary pieces: internal costs, outsourcing costs and inventory carrying costs. Each one is described below, with its methodology and an example when appropriate.

Internal SCM and logistics costs:

Internal SCM and logistics cost encompass all logistics activities that occur within a firm, such as a manufacturer, wholesaler or retailer. It excludes all outsourced logistics activities and all production process. Individual firms can evaluate their internal logistics cost by adding their respective logistics cost activities and their components as stated in the table below.

Internal Logistics Cost activities Inbound and outbound transportation Transportation management Warehousing Materials handling Order fulfillment Logistics network design Inventory management Supply/demand planning Management of third party logistics services providers Custom brokerage Logistics and SCM technology management Sourcing and procurement processes (excluding purchase of goods cost)

Internal Logistics Cost Components of Activities Logistics wages cost Logistics infrastructure depreciation Logistics technology investment depreciation Transport equipment depreciation Training cost related to logistics position Logistics management cost

Internal SCM and logistics costs are the most complex to calculate since no organization accounts for these. The estimates of internal logistics costs in this report were compiled via the following methodology:

1. Determine the occupational types related to logistics, and link those to logistical activities. In total, twenty-one occupations were found and assigned to one of the four logistics activities namely: Distribution Centers (DC), Office work, Truck transportation and Other transportation (rail, etc.). For example, material handlers are linked to DC activities, while customs & ships brokers and industrial engineering and manufacturing are part of office related activities.
   
   
2. Find for each industrial sub sector the number or persons in each occupational sub category. There are sixty sub sectors in manufacturing, thirty in wholesale and thirty in retail.
   
   
3. Find the logistics’ suppliers equivalent to the four logistics’ activities from above. For example, under Office work were included the consulting services’ and support to transportation and warehousing’ personnel.
   
   
4. Calculate the wage bill of the four logistics activities after occupations were linked to them. The ratio of the total costs divided by the wage bill is then charged to the sixty sub sectors in manufacturing, to the thirty sub sectors in wholesale and to the thirty sub sectors in retail. For example, for each dollar spent in salaries, it is known that in average 2$ are spent on infrastructures, technologies and management costs.

All this allows the estimation of the logistics and SCM costs for each industrial sub sector.

Outsourcing costs: 

Outsourcing costs encompass activities assigned to a third-party. Outsourcing costs come from input-output tables from Statistics Canada that indicate how much each industry requires of the production of each other industry in order to produce each dollar of its own output by compiling the purchases of logistics services by users.

Using the purchases that originate as part of logistics activities is appropriate, instead of using the sales, because it avoids multiple counting.

Example

A manufacturing firm writes a check for $10 million to a 3PL to assume all its distribution activities for the current year. That 3PL does not actually own trucks, and hire a transportation broker to actually contract the required vehicles as necessary, for that same amount. The transportation broker will sign multiple deals during that year with transportation companies, again totaling $10 million. By looking at the sales figures in the input-output tables, the logistics activity in that scenario would now total $30 million. Utilizing instead the purchases of logistics services allows isolating the real logistics activity, which is indeed $10 million.

An example of the activities that are outsourced and/or done inside a company is displayed in the chart below.

In-House and Outsourced Supply Chain¹².

Description Link

As can be seen, outsourcing differs largely according to the type of activity. Certain activities are largely outsourced, such as Customs Clearance or Customs Brokerage, and others are mainly done in-house, such as Inventory Management and Customer Service.

Inventory Carrying Cost:

Lexi-Com’s Glossary of Logistics Terms defines inventory carrying cost as follows. One of the elements comprising a company’s total supply chain-management costs. These costs consist of the following:

1. Opportunity Cost:  The opportunity costs of holding inventory. This should be based on your company`s own cost of capital standards using the following formula. Calculation: Cost of Capital x Average Net Value of Inventory
   
   
2. Shrinkage:  The costs associated with breakage, pilferage, and deterioration of inventories. Usually pertains to the loss of material through handling damage, theft, or neglect.
   
   
3. Insurance and Taxes:  The cost of insuring inventories and taxes associated with the holding of inventory.
   
   
4. Total Obsolescence for Raw Material, WIP, and Finished Goods Inventory:  Inventory reserves taken due to obsolescence and scrap and includes products exceeding the shelf life, i.e. spoils and is no good for use in its original purpose (do not include reserves taken for Field Service Parts).
   
   
5. Channel Obsolescence:  Aging allowances paid to channel partners, provisions for buy-back agreements, etc. Includes all material that goes obsolete while in a distribution channel. Usually, a distributor will demand a refund on material that goes bad (shelf life) or is no longer needed because of changing needs.
   
   
6. Field Service Parts Obsolescence:  Reserves taken due to obsolescence and scrap. Field Service Parts are those inventory kept at location outside the four walls of the manufacturing plant i.e., distribution center or warehouse.

What inventory carrying costs do not consist of: 

• all the necessary handling of the goods and/or materials
• the depreciation of the goods and/or materials.

Those are actually already included in the internal logistics costs above.

Inventory Carrying Cost Rate: The inventory carrying cost rate is applied on the average annual inventory in order to estimate the cost of having inventory into a specific firm or industry. The average industry accepted and used rate is estimated at 20 percent ¹³.

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Inventory carrying costs and outsourcing costs cannot be put in terms of GDP, since they are accounting-based, and not a real economic activity. Both are compared to gross margins.On the other hand, internal costs can be compared both to GDP and to gross margin.

Logistics and SCM costs vary widely by sector. The proportion of internal costs, outsourcing costs and inventory carrying costs is also different between sectors. For example, in a JIT mode, internal costs tend to increase, but this is balanced by a reduction in the inventory carrying costs; this happens in volatile sectors, such as upscale clothing, computers and perishable goods.