(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.

2
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 9
4.1.2 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

3
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 are
adopting. 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.

4
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 meet
organisational 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.

5
 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 system
increases 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).

6
 (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

7
more than one. Johnson, et al. (2008) argue this idea is inline with
cost efficiency since running one big plant is cheaper than
maintaining multiple warehouses, which leads to achieve
economies of scale.
- Lowering the total cost, by lowering different costs by
decreasing the number of inventories as well as the cost of
transportation remaining the same.
- Droge, and Germain, (1989) argue that other advantages include a
massive output of products/services being delivered due to having a
centralised decision making system.
• Slack, Chambers, and Johnston, (2004), cited by Barnes (2008)
discuss operations performance criteria, including quality, reliable
delivery, flexibility which includes fast delivery, and cost, which if a
company could achieve, competitive advantage would be reaped.
Those performance criteria are inline with other advantages, which are
achieved by centralising distribution. these include:
- Lead-time will be shorter and safer for all products at any location.
- Better delivery services, as this leads to achieving efficiency through
more reliable deliveries.
- Fast and flexible response to customers' demand.
- Although products will be shipped over a long distance to reach
customers because they need to be transferred from the central warehouse,
the total cost of the transportation won’t be very high, and that’s because
there’s no need for urgent transport. For example, in the decentralised
warehouses, if some stocks were to run out, there would be need for
emergency transportation from the manufacturer. To achieve the latter, an
urgent transportation would be required to deliver the required product.
These might require either air transportation; or via fast delivery, which
are both costly (Kohn, 2005).

8
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.

9
 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 are
kept 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,

10
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.

11
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,

12
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.

13
 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

14
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.

15
- 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 and

its
Environmental 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.

16
 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).

17
 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 in
producing and equipment for the many surrounding companies. Just over a decade
ironmoulds
later the was restructured and given the new name Lind‫ه‬s Gjuteri & Formfabriks AB
company
(Lind‫ه‬s
Foundry & 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 the
daily
newspaper in order to find a company that was able to manufacture the products his
company
developed, namely pumps. The Stenberg brothers responded to the advert and the
cooperation
between Hilding Flygt and the Stenbergs in Lind‫ه‬s saw the light. About a year later the
company
was 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 Flygts
Pumpar wasStenberg brothers in Lind‫ه‬s. In the same year the company introduced the
sold to the
world’s
first submersible pump thanks to the engineering knowledge of Sixten Englesson, an
employee of Over the subsequent years the company introduced new pumps,
the company.
started an and
company, export
established foreign subsidiaries. In 1968 the American multinational
company
International Telephone & Telegraph Corporation, better known as ITT, acquired the
company
through an exchange of shares, and the following decade the Lind‫ه‬s plant grew
tremendously
an as
expanding range of products were introduced. Later on, in 1991, the company
name was
changed 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 is
renowned for producing efficient and versatile products of the highest quality. ITT
Flygt’s vision
is to be recognised as the leading supplier of solutions and services in fluid handling
with

19
submersible products worldwide. In trying to live up to this reputation as a market
innovator has
company the recently released the N-pump, which promises to revolutionise
submersible
pumping, much in the same manner as the first submersible pump did just over half a
century
ago.

3.1.2 Facts and figures

With its 44 wholly or partly owned sales offices, representation in over 130 countries
around the
world, production plants in Sweden, Germany, the Netherlands, Argentina, and China,
and
distribution centres in Sweden and France, ITT Flygt can truly be considered an
international
company. The company has over 4,000 employees, of which over 2,500 are stationed
outside
Sweden.ofThe corporate headquarter is located in Stockholm, as well as the
departments of
Research & Development, Marketing, Flygt International, and the Swedish sales
company. The
largest production plant is located in Lind‫ه‬s, where the company has its roots, and in
2003
approximately 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, and
IT/IS are that are divided between Lind‫ه‬s and Stockholm. Figure 21 below shows an
functions
organisational chart of the ITT Flygt Group.

ITT Flygt Group

CEO

Product Management Operations Product Management Finance

Research & Manufacturing & BU – Public Utiliy Information Technology,

Development Distribution Bus. Proc. Development,
Quality & ESH

Technical Support Lind‫ه‬s Plant BU – Construction & Human Resources &

Mining Corporate Communication
Market Communication

Research & Flygt Werk BU – Industry

Value Based Six Sigma
Development – other
units

SDC Metz Region Europe

Business Development

Group Purchasing, Region Americas

Logistics & Production
Engineering

Manufacturing Region Asia Pacific

Figure 21: Organisational chart of the ITT Flygt Group

20
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 developing
fluid
systems and solutions in order to move and control water and other fluids. Fluid
Technology is
one of four business areas, where the other three areas include Electronic
Components, Defense and Motion & Flow Control, and represents 40 % of total sales
Electronics & Services,
for ITT
Industries. The corporate headquarter of ITT Industries is located in White Plains, New
York
and the company employs about 38,000 people all over the world. It is noted on the
New
StockYork
Exchange as well as on the stock exchanges US Midwest, US Pacific, London,
Paris, and
Frankfurt.

3.1.3 The market

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

2% 9%
3% Africa and the Middle East
Asia and the Pacific Ocean
South America
28%
58% 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 and
the pumps
are used in various settings and environments. For instance they are used to pump
waste-water in
the London Docklands, to drain mines in South Africa from water, or to create man-
made
surfing waves in Texas. Just as with most other industries ITT Flygt has a number of
companies
with whom it needs to compete over market shares and currently some of the larger
competitors
include Grundfos and ABS Pumps.

Earlier ITT Flygt considered the market in a somewhat narrow manner, or rather the
market was
defined as just selling pumps, and with this view the company considered itself to
have a market
share of approximately 25 %. Today, the company defines the market in a broader
fashion and

21
the goal is not only to supply a submersible pump, but instead to supply a complete
system installation and other services. When the market is defined by using these
including
criteria,
ITT Flygtthen
instead considers its market share to be approximately 5-10 %. However, the
company
has presented an offensive strategy for the coming years, a strategy where the
company shall
grow substantially over the coming years and increase its overall market share. This
expansion
shall be achieved through extensive acquisitions as well as increases in sales on
markets outside
Europe and of
the U.S.

3.1.4 The pump

Even though many of the pumps ITT Flygt in fact sell look and operate in a similar
fashion,
companythe
does not have a standard or pre-specified product that the customer can
pick out from
a catalogue in the same manner as they could do if they bought something from Elfa or
IKEA.
This is because a product can come in more or less a million different configurations,
since
cables, voltage for motors, or material for the sealing jointing and the like can vary
depending on of the customer in question. Figure 23 below illustrates typical
the preference
products of ITT
Flygt.

Figure 23: Typical ITT Flygt pumps

Until the 1960s ITT Flygt was a rather small company and it was not that difficult to
specify what each of the products were to have as they were ordered, since volumes
components
were
large not
andthat
therefore the workload was manageable. Sales representatives went out
into the field
and sold pumps to the customers through the use of brochures, technical
specifications,
curves etceteraeffect
and could quite easily specify the characteristics that described a
certain product.
These were then transferred to the factory where personnel translated these orders
into specific
articles so that the customers received the pump they actually requested. These lists
could
contain, depending on the type of pump, between 50 and 100 articles.

22
When ITT Flygt started expanding on new markets and the volumes started to grow,
this way was
working of no longer feasible since this would be too time consuming. Therefore, the
company
in the 1970s introduced an identity system, a system that had the purpose of making
it possible
identify all to
objects, e.g. single parts, components, or a complete unique product. This
system
be seencan
described as an “identity pyramid” and Figure 24 below gives an example of
what
look like. may
this

CP 3085 Sales denomination

3085.182 Product code

308
5.182-010 Module

308
5.182-0025 Product number

3085.182-010-1
51-232-300- Delivery code (module combination)
414-599-699-700-80
5-999

3085.182-9511235 Serial number

82 40 59, 397 75 00 Parts

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

When a customer today sees a pump, the sales representative sees a product code
according torules that the company have decided upon in the technical administration
the identity
system.
The order is then handled by the order personnel, who for that particular product
group match
customer requirements with the matching articles in each of the module groups, e.g.
motor
module 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 out
to beefficient
very a way of describing all the parts, components, and modules, and it has
become clear
and easy to see all available product combinations.

23
24