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IJPDLM 34,6

Strategic logistics decision making

Peter F. Wanke
Center for Logistics Studies, COPPEAD The Graduate School of Business Administration, Federal University of Rio de Janeiro, Rio de Janeiro, Brazil, and

466
Received May 2003 Revised September 2003, November 2003

Walter Zinn
Fisher College of Business, Ohio State University, Columbus, Ohio, USA
Keywords International business, Distribution management, Order systems Abstract Logisticians must make strategic level decisions in order to manage uncertainty, customer service and cost. This research explores the relationships between three strategic level decisions and selected product, operational and demand variables. The three strategic decisions are: make to order vs make to stock; push vs pull inventory deployment; and inventory centralization vs decentralization. The data used to study the relationships were collected in an international environment and analyzed with correlation analysis and logistic regression. Results suggest that the three strategic decisions are each explained by specic product, operational and demand variables.

Introduction Logistics managers are involved in three strategic level decisions: (1) Make to order vs make to stock. (2) Push vs pull inventory deployment logic. (3) Inventory centralization vs decentralization. These decisions are equally required in domestic and international contexts. Managers must make strategic choices to cope with the issues of uncertainty, customer service and cost management. For instance, Dell Computer elects to make to order and pull demand by only manufacturing and distributing computers in response to a customer order. This strategic approach allows the company to maintain a minimal investment in inventory. In contrast, Hewlett-Packard, a direct competitor of Dell, elects to manufacture products to stock on the basis of a sales forecast. Strategic decisions are a function of product, operational and demand related variables such as delivery time, obsolescence, coefcient of variation of sales and inventory turnover. For example, if customers require a short delivery time, logistics managers are more likely to decentralize inventory in order to stock product nearby the customers facility. The relationships between product, operational and demand related variables and the three strategic decisions have been previously studied in the literature. For instance, Leeuw et al. (1999) look at products markets and processes as determinants of distribution control techniques such as centralization of inventory and reorder planning. Similarly, Pagh and Cooper (1998) show how product, market and operational characteristics are determinants of supply chain postponement/speculation strategies.

International Journal of Physical Distribution & Logistics Management Vol. 34 No. 6, 2004 pp. 466-478 q Emerald Group Publishing Limited 0960-0035 DOI 10.1108/09600030410548532

Accordingly, the purpose of this exploratory research is to help managers understand further the impact of product, operational and demand related variables on each of the three strategic decisions described above. More specically, this research extends previous work by adding an international context, ranking product, operational and demand variables and then quantifying key relationships among them and suggesting how the relationships uncovered among the variables and strategies in the research may impact on the current state of logistics management initiatives such as just in time (JIT), efcient consumer response and vendor managed inventory. Key ndings suggest that the relationships obtained in an international context generally match previous research. The results further suggest that in quick replenishment systems with a sufciently short delivery time requirement, demand information visibility does not necessarily lead to a pull system where companies move product in reaction to demand input. A nal key nding suggests that delivery time is a signicant variable in all three strategic decisions included in this research. The remainder of the paper is organized into four sections, starting with a literature review. This is followed by a methodology section that includes a justication for the product, operational and demand variables included in the research. The last two sections contain the results and the conclusions and managerial implications respectively.

Strategic logistics decision making 467

Literature review In this section, we present the theoretical evidence available in the literature. We begin with make to order vs make to stock. Push vs pull and centralization vs decentralization follow. Make to order vs make to stock We looked at six variables with a reported relationship with the make to order vs make to stock decision: process technology, obsolescence, perishability, lead time ratio, delivery time and coefcient of variation of sales. The greater the potential obsolescence of a product, the greater the propensity towards make to order. This is because the risk of holding inventory is high and rms manage it by only producing already sold items (Magretta, 1998). Coefcient of variation of sales is analogous to obsolescence (Pagh and Cooper, 1998). Recall that the lead time ratio is the quotient of the delivery time over the supply lead time. This number captures, in essence, the time available to manufacture a product once it is sold. The smaller the time available (small lead time ratio), the more likely products will be made to stock (Stalk, 1998; Romero, 1991). Perishability is also expected to signicantly impact on the make to order vs make to stock decision. The greater the perishability of the nal product, the more likely that products are made to order to avoid loss of inventory (Abad, 2003). In contrast, a short delivery time is said to be an incentive to make to stock (Li, 1992). Process technologies are either continuous or discrete (Hayes and Wheelwright, 1984). Make to order decisions are more frequent in discrete process industries (e.g. automotive) than in continuous process industries (e.g. chemicals) (Kwan, 1999; Zipkin, 2001). This is because discrete processes are more exible than continuous processes from a manufacturing point of view (Landvater, 1997).

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Push vs pull inventory deployment logic There are many denitions commonly linked to the terms push and pull and there seems to be misunderstanding about what these terms really mean (Leeuw et al., 1999). In this paper we adopt the denition provided by Ballou (1992) for the push vs pull decision in logistics systems. The push decision moves products on the basis of planning or forecasting. On the other hand, the pull decision moves products based on demand. Since lower inventory levels are more likely to be achieved under pull rather than push decision (Wanke and Fleury, 1999), variables that affect the magnitude of inventory risks and carrying costs may inuence the pull decision. The push vs pull decision is affected by three of the ve variables impacting on the make to order vs make to stock decision. Pull decisions are linked to obsolescence and delivery time. The former because rms do not desire to maintain excess inventory of nished goods that are in risk of becoming obsolete (Dell, 1999). The latter is related to pull because rms may not need to forecast if delivery times are long (Inman, 1999). Finally, perishability is analogous to obsolescence (Abad, 2003). Two additional variables are related to push vs pull: demand information visibility and cost of good sold. Demand information visibility is the extent that actual demand information penetrates a supply chain towards the initial supplier. This concept is also known as demand decoupling point (Christopher, 2000) or order penetration point (Sharman, 1984). The key idea is that companies rely on planning inventories in the absence of actual demand information. Recall that the cost of good sold represents the amount of working capital required to produce an additional unit. A higher cost of good sold may lead to pull decision because the expensive inventory is an incentive to react to demand rather than to plan and inventory products (Pires, 1999). Inventory centralization vs decentralization Cost density, coefcient of variation of sales, inventory turnover and delivery time are variables that may affect inventory decentralization. The lower the cost density, the higher the pressure to keep transportation unit costs low (Amstel and Amstel, 1985). Freight consolidation, which spreads transportation xed costs, can be achieved through inventory decentralization (Carter and Ferrin, 1996). The impact of freight consolidation on the time interval between two consecutive replenishments, and therefore on inventory turnover, should also be considered (Jayaraman, 1998). Inventory turnover tends to be lower if freights are consolidated. On the other hand, higher inventory turnover could lead to inventory decentralization since it indicates that the replenishment is attuned to demand variation. Shorter delivery times could also lead to inventory decentralization if the transportation mode remains the same (Bowersox and Closs, 1996). As mentioned before, the coefcient of variation of sales impacts on inventory centralization decisions.

Methodology The methodology section begins with a justication for the variables selected. This is followed by a description of the data collection and analysis procedures. The section also contains two tables listing the industries included in the research and operational denitions for the variables selected.

Variable selection Ten predictor variables are included in the research. Four are product related (cost of good sold, obsolescence, perishability and cost density); three are operational (lead time ratio, demand information visibility and process technology); and the last three are demand related (delivery time, coefcient of variation of sales and inventory turnover). The cost of good sold drives the value of the inventory (Lambert et al., 1998). When product costs are high rms are more likely to react to demand and therefore pull (Jones, 1991). Dell (1999) suggests that obsolescence is a critical variable in the make to order vs make to stock decision. When companies make product to stock they risk lessening the value of the inventory whenever a product is replaced by a substitute. Perishable products are risky to inventory and therefore affect decisions to make to order, pull distribution and centralization (Wanke, 1999). Cost density is suggested as a variable by Pagh and Cooper (1998). It refers to the ratio of the sales price to weight or cube. High cost density products are expensive to inventory and relatively inexpensive to move, which possibly drives decision makers towards inventory centralization. The lead time ratio is the quotient of the delivery lead time over the supply lead time. It captures the time available for manufacturing operations that, according to Romero (1991) and Inman (1999), is an indicator of the feasibility of making products to order. Sharman (1984) and Christopher (2000) suggest that rms are more likely to push product or rely on planning logics when demand information visibility is low. Inventory centralization decisions are affected by sales uncertainty (Zinn et al., 1989). The coefcient of variation of sales measures uncertainty as the ratio of standard deviation over average. Process technology is related to continuous or discrete product ow in manufacturing. Firms are more likely to make to order when process technology is discrete (Kwan, 1999). A short delivery time is often associated with a make to stock policy (Wemmerlov, 1984). Finally, the inventory turnover is widely known as a measure of inventory velocity. A quick turning inventory may be a driver for decentralization because it indicates that the rm is attuned to demand variation. Data collection and analysis To understand the impact of the research variables on the three strategic level decisions examined in this exploratory research, we conducted a series of personal interviews. The interviewees are logistics managers involved with decision making related to the three strategic level decisions. Each manager was asked to provide corporate data for two key SKUs. The personal interview is necessary for cultural reasons because there is limited tradition in Brazil to answer written surveys (Sarel and Zinn, 1992). The companies and subjects were selected with the following process. First, we identied the six largest manufacturing industries in Brazil, as ranked by Exame 500 Melhores e Maiores, a Brazilian magazine similar to Forbes 500. The six manufacturing industries are: (1) Chemical and petrochemical; (2) Food; (3) Automotive; (4) Appliances; (5) Computers. (6) Pharmaceuticals.

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We then selected for each industry a convenient sample of 10 percent of listed companies. Each selected company was invited to participate in the study. Refusals were substituted by the next company in the list. Companies that agreed to participate were asked to provide data on two SKUs. One of the SKUs is classied as A (top 20 percent in sales) and the other a C item (bottom 5 percent in sales volume). The sample information is summarized in Table I. The data collected are summarized in Table II. It shows descriptive statistics (means and standard deviations) for each variable and strategic decision included in the research. Table II also provides an operational denition for each variable. The data analysis plan is as follows. The relationship between each variable and each strategic decision was initially tested with a simple correlation. The goal is to
Industry Chemical and petrochemical Food Automotive Appliances Computers Pharmaceutical Total Size 46 40 31 26 21 17 181 Sample size 5 5 3 4 4 5 26 Sample fraction (%) 10.9 12.5 9.7 15.4 19.0 29.4 14.4

Table I. Industry and sample sizes

Variables Cost of good sold ($) Obsolescence Perishability Lead time ratio Demand information visibility Delivery time Process technology Cost density ($/kg) Coefcient of variation of sales Inventory turnover (turns/year)

Denition

Mean

Std dev.

21,458.26 77,435.09 1 / (Life cycle length in months) 0.03 0.05 1 / (Shelf life length in months) 0.14 0.29 (Finished product average delivery time in days) / (Raw material average delivery lead-time in days) 0.16 0.33 If yes, then 1 If no, then 0 0.23 0.43 Time from order placement to order delivery in days 5.34 11.26 If continuous, then 1 If discrete, then 0 0.58 0.25 (Cost of good sold) / (weight in kilograms) 1,889.89 11,055.20 (Standard deviation of sales) / (sales average) 0.4499 0.176 (Annual sales units) / (Average inventory level units) 29.00 33.16

Table II. Operational denitions of variables and strategic decisions

Strategic decisions Centralization vs decentralization If decentralization, then 1 If centralization, then 0 Make to order vs make to stock If make to stock, then 1 If make to order, then 0 Push vs pull If pull, then 1 If push, then 0

0.62 0.77 0.31

0.49 0.43 0.46

search for signicant relationships. The focus of the analysis is on the sign of the relationship. The second step in data analysis is logistic regression. The regression method is stepwise backward. The goals are to understand the collective effect of the research variables on each of the strategic decisions and rank predictor variables in order of importance. The logistic regression has the additional goal of validating the sign and signicance of the results obtained with the simple correlation analysis. Managers may benet from the corroboration because it validates the use of the simple correlations, which is computationally simpler. Results In both the simple correlation analysis and the logistic regressions, we found a number of signicant results. We adopted p-values below 0.10 as the cut-off point for signicance in this research. The simple correlation ndings shown below corroborate previous ndings in the domestic literature. This suggests that domestic research results may be extensible to an international context. The logistic regression presents models with multiple predictor variables for each strategic decision. These results are presented separately for each strategic decision, beginning with make to order vs make to stock. Make to order vs make to stock Based on the literature review, we examined the correlations of six predictor variables with the strategic decision to make to order vs make to stock. Results are in Table III. Note that all variables have been standardized to reduce the effect of multicollinearity in the logistic regression analysis. The exception is process technology, which is a dummy variable. Results are signicant at different levels for ve variables. The rst four variables are signicant at the 0.01 level, while obsolescence is signicant at the 0.05 level. Delivery time has a negative sign with respect to the strategic decision. This means that the longer the delivery time, the more likely that the rm will make to order. This conrms the results obtained by Li (1992). Process technology has a positive sign. This means that rms utilizing continuous manufacturing processes are more likely to make to stock. This result is a quantitative corroboration of both Hayes and Wheelwrights (1984) and Zipkins (2001) postulates to this effect. The lead time ratio is the quotient of the delivery time over the supply lead time. The negative sign of the correlation indicates that rms with a high lead time ratio are more likely to make to order. This is because the high ratio indicates a long time available for the manufacturing process.
Variables Delivery time Process technology Lead time ratio Coefcient of variation of sales Obsolescence Perishability Correlation 2 0.577* 0.455* 2 0.384* 2 0.366* 2 0.302** 0.253 n 46 52 46 48 48 48

Strategic logistics decision making 471

Notes: *Correlation signicant at 0.01 (two-tailed); **Correlation signicant at 0.05 (two-tailed); Make to order (0) vs make to stock (1)

Table III. Correlation results for make to order vs make to stock strategic decision

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Stalk (1988), Romero (1991) and Inman (1999) obtained equivalent results. The coefcient of variation of sales is also signicant and negative with respect to the strategic decision. This suggests that the more stable the sales pattern, the more likely it becomes that the rm produces to stock, as previously reported by Pagh and Cooper (1998). Finally, the negative sign demonstrates also that obsolescence is inversely related to the decision to make to stock vs make to order. As previously shown by Dell (1999), rms are more likely to make to order whenever nished goods are at risk of becoming obsolete. Table IV shows the results of the logistic regression for the make to order vs make to stock strategic decision. Only two variables, delivery time and coefcient of variation of sales, are signicant at the 0.10 level. In each case, the sign of the relationship with the criterion variable corroborates the results of the simple correlation analysis. Delivery time is ranked as the most important variable, followed by the coefcient of variation. Thus, the logistic regression also suggests that managers should focus on delivery time and coefcient of variation of sales as indicators of the make to order vs make to stock decision. As an additional analysis of results, we looked at the relationship between the two predictor variables in the logistic regression. The relationship is summarized in Figure 1. Clearly, when both variables have low values, the probability that the rm will make to stock is high. Conversely, when both variables have high values, the probability that the rm will make to stock is low. Figure 1 also shows that when the coefcient of variation is very high (above 90 percent), the rm will make to order regardless of the value of the delivery time. The same is true for delivery time values greater than 18 days. The rm will make to order
Variable B 2.328 2 5.370 2 1.601 Wald 3.825 6.444 2.533 Signicance 0.050 0.011 0.098

Table IV. Logistic regression results: make to order vs make to stock strategic decision

Constant Delivery time Coefcient of variation

Notes: Criterion variable: make to order vs make to stock; R square = 0.751; Chi-square for the model = 21.265 (Sig. = 0.000)

Figure 1. Indifference line for the make to order vs make to stock strategic decision

regardless of the coefcient of variation. In practice, however, the above extremes are rare. An examination of the data collected shows that a majority of the companies included in the research reported delivery times under ve days with coefcients of variation that are reasonably uniformly distributed. This explains why a majority of companies adopt a make to stock strategy. Finally, Figure 1 provides insight into the nature of JIT replenishment systems, which are commonplace among the manufacturing rms included in the research. JIT requires very short delivery times of the supplier, which also means that the rm must use a make to stock strategy. This does not present a problem if the customer is predictable (i.e. low coefcient of variation of sales). On the hand, an unreliable customer may use its power to force the supplier into a sub-optimal make to stock strategy when Figure 1 shows that a make to order strategy is recommended. Push vs pull inventory deployment logic The simple correlation analysis for the push vs pull strategic decision spanned ve variables: (1) Delivery time. (2) Cost of good sold. (3) Obsolescence. (4) Perishability. (5) Demand information. Recall that push vs pull is a dummy variable with values of zero for push and one for pull. Results show that three of the variables are signicant: delivery time and cost of good sold at the 0.01 level and obsolescence at the 0.05 level. Delivery time has a positive sign. This means that the longer the delivery time, the more likely that the rm will decide to pull inventory. When this happens, rms move the inventory in response to actual demand, as opposed to a sales forecast. This conrms earlier results by Inman (1999). The cost of good sold also has a positive sign. More expensive products are more likely to be pulled. The rm is more likely to delay product movement down the channel until demand information is available, as anticipated by Pires (1999). Finally, the likelihood that a product will become obsolete increases the chance that rms will pull inventory. The sign of the relationship is therefore positive, as corroborated in Dell (1999). The above results are summarized in Table V.
Variables Delivery time Cost of good sold Obsolescence Perishability Demand information visibility Correlation 0.495* 0.423* 0.346** 20.238 0.229 n 46 43 48 48 52

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Notes: *Correlation signicant at 0.01 (two-tailed); **Correlation signicant at 0.05 (two-tailed); Push (0) vs pull (1)

Table V. Correlation results for push vs pull strategic decision

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The logistic regression with push vs pull as the criterion variable indicates that two predictor variables signicantly impact on this strategic decision: delivery time and demand information visibility. The former is signicant at the 0.01 level and the latter at 0.10. This result corroborates the positive sign in the relationship between delivery time and push vs pull. Because obsolescence is somewhat correlated to delivery time (0.302, p , 0:05), the sign of the variable obsolescence is also conrmed, albeit weakly. Finally, the result for demand information bears an additional comment. This variable failed to show a signicant simple correlation with the strategic decision, but appears signicant in the logistic regression. This happens because demand information is a dummy variable that is better dealt with by a logistic regression than a measure of simple correlation. In sum, the analysis presents evidence that managers should focus primarily on delivery time when making push vs pull decisions and secondarily on demand information. The results of the logistic regression are presented in Table VI. The relationship between the two predictor variables is shown in Figure 2, which depicts two probability lines. When the probability is above 0.50, the recommended strategy is pull. Push is recommended if the probability is below 0.50. The rst line (on the left) assumes that the supplier has access to his customers actual sales. The recommended strategy is push if the delivery time is below 3.8 days and pull when delivery time is above that. In the curve on the right, there is no demand information. In this case, the indifference point is 6.3 days. Whenever the delivery time is below two
Variable Constant Delivery time Demand information B 0.123 6.905 1.666 Wald 0.024 6.771 3.488 Signicance 0.876 0.009 0.062

Table VI. Logistic regression results: push vs pull strategic decision

Notes: Criterion variable: push vs pull; R square = 0.543; Chi-square for the model = 25.266; (Sig. = 0.000)

Figure 2. Probability lines for the push vs pull strategic decision

days, the recommended strategy is push regardless of the availability of demand information. At the other end of the spectrum, the recommended strategy is always pull if the delivery time is 14 days or greater. The attempt to implement efcient consumer response (ECR) strategies in the grocery business provides an illustration of the relationship between delivery time and demand information (Mathews, 1997). Suppliers promised to reduce delivery time in exchange for greater demand information visibility. In other words, the proposal was to move the probability curve to the left. This moved the indifference delivery time down from 6.3 days to 3.8 days in the example above. The recommended strategy with demand information is a pull system for delivery times above 3.8 days. In practice, however, retailers demanded very short delivery times that are in the push strategy recommended area, which failed to provide an incentive for suppliers to move to a pull system. Inventory centralization vs decentralization In the case of the strategic decision to centralize or to decentralize, four variables are considered as a result of the literature review. The four variables are in Table VII. The strategic decision to centralize or not is a dummy variable where zero represents centralize and one decentralize. The simple correlation analysis suggests that two of the variables, inventory turnover and delivery time, have a signicant relationship with the strategic decision. Inventory turnover has a positive sign. This means that the faster the inventory turns, the more likely that the rm will decentralize inventory. This result parallels Jayaraman (1998). Conversely, the delivery time has a negative sign. The longer the delivery time, the more likely that the rm centralizes inventory, as also stated by Jayaraman (1998). Table VIII presents the results of the logistic regression. The sign identied in the simple correlation is conrmed for both variables. Results also indicate that delivery time is the most important predictor of the centralization vs decentralization decision.
Variables Inventory turnover Delivery time Cost density Coefcient of variation of sales Correlation 0.308* 2 0.279* 2 0.206 2 0.171 n 46 46 40 48

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Notes: *Correlation signicant at 0.05 (two-tailed); centralize (0) vs decentralize (1)

Table VII. Correlation results for the centralization vs decentralization strategic decision

Variable Constant Inventory turnover Delivery time

B 0.064 1.734 22.744

Wald 0.020 5.749 3.108

Signicance 0.887 0.016 0.078 Table VIII. Logistic regression results: centralization vs decentralization strategic decision

Notes: Criterion variable: inventory centralization vs decentralization; R square = 0.257; Chi-square for the model = 9.652 (Sig. = 0.008)

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The relationship between delivery time and inventory turnover is examined below. It shows that delivery time dominates the relationship. Firms centralize inventory at any level of delivery time if the inventory turnover is below 16 turns a year. As delivery time increases, the minimum inventory turnover needed to recommend decentralization also increases. In fact, most observations in the research indicate delivery times under ve days and inventory turnovers under 40 turns per year. Within that range, decentralization is only recommended for products with a fast turning inventory. The concept of a vendor managed inventory (VMI) may be used to illustrate the choice between centralization vs decentralization under different inventory turnover and delivery time trade-offs. In VMI, the suppliers inventory is held at the customers location and deliveries to the customer are almost instantaneous. The key managerial issue is how the supplier should replenish the inventory at the customer. The choices are a centralized inventory coupled with a longer delivery time or decentralized inventory closer to the customer where deliveries are fast. Figure 3 illustrates the indifference points between the two choices.

Conclusions and managerial implications Recall that the purpose of this research is to help managers operating in an international context to understand the impact of product, operational and demand related variables on each of the three strategic decisions presented. The results obtained internationally conrm results published in the current domestic literature. We further found that there are important variables that a manager should focus on before making each strategic decision. These variables, ranked by importance to each strategic decision, are in Table IX.

Figure 3. Indifference line for the centralization vs decentralization strategic decision

Make to order vs make to stock Table IX. Strategic decisions and signicant variables Delivery time Coefcient of variation of sales

Push vs pull Delivery time Demand information

Centralize vs decentralize Inventory turnover Delivery time

Results show that no decision should be made on the basis of the value of a single variable. At least two variables and their relationship impact on each decision. In fact, the relationships help explain some of the managerial initiatives observed in logistics management today. First, JIT is related to the relationship between the coefcient of variation of demand and the delivery time. It shows how a reliable customer has a positive impact on a suppliers decision to make to stock, which is a requirement of JIT systems. Managers need to drive down the coefcient of variation prior to implementing a JIT system. Second, the apparent failure of ECR may be explained by the relationship of delivery time and a suppliers information of customer sales data. ECR is, by design, a pull system. However, when customers demand very short delivery times, we show that a push system is the preferred strategy for the supplier, because anticipatory movement of product becomes necessary to meet delivery deadlines. Thus, managers benet from computing and understanding the effect of very short delivery times on a suppliers ability to implement a pull system Finally, a suppliers choices to resupply a customers inventory managed by VMI are illustrated by the relationship of inventory turnover and delivery time. It shows that suppliers have the choice to quickly turn inventory near a customer or increase delivery time but slow inventory turnover. There is a clear benet in quantifying inventory turnover and delivery time trade-offs when managing a VMI system. In conclusion, while exploratory in nature, results presented in this research suggest that product, operational and demand data may prove useful in making strategic level decisions in logistics.

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