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Professor’s Math Model Could Save Manufacturers Millions in Distribution Costs

April 02, 2015
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Hari Natarajan, associate professor of operations and supply chain management.

Manufacturers spend $150 billion dollars per year to get their products via third-party logistics providers (3PLs) to big retailers. Often, this is the result of myopic and ad hoc rate agreements with carriers.  But new research from the School’s Hari Natarajan, associate professor of operations and supply chain management, published in IIE Transactions, says by using a newly-developed price optimization and customized negotiation support model, manufacturers can save nearly 10 percent in distribution costs to retailers annually.

The first quarter of the year is a time when manufacturers evaluate the recent holiday shopping season to think ahead to distribution needs for the year. Increasingly, they are choosing to focus on their core competencies and outsource distribution needs to 3PLs to get products to stores, especially for less than truckload (LTL) shipments that involve additional logistical detail.  Recent studies have shown that 82 percent of manufacturers are now dependent on help from outside to move products to retailers. 

With this growing trend comes real and expensive challenges, one of the greatest being properly estimating budgets for 3PLs to get products to stores.  Today, rates are typically based on tables provided by the rating engines of transportation data companies.  However, these rate tables do not offer a good price indicator because they do not reflect the long-term collaboration between manufacturer and 3PL, the variability in quantities shipped, and/or the periodic nature of the deliveries. 

“Our math model provides a much-needed tool in the industry that considers various aspects that play into distribution costs, and offers a structured approach to negotiating customized rates with 3PLs that also offer cost-savings to manufacturers,” said Natarajan, who developed the model along with a University of Texas at Austin professor. 

The solution frames the problem of negotiating delivery fees as an optimization model that considers: the distance of each store from the distribution center; the probability of delivery weights to each store; and the total delivery cost incurred by each 3PL provider.  It then offers a tailored solution that takes into consideration both industry benchmarks and the specifics of the manufacturer-3PL partnership. 

The researchers applied the math model to actual data from a building product manufacturer and found that it was able to generate significant savings in distribution costs while ensuring fair compensation to distributors. 

“We based the model on building product manufacturers but are confident it could work for many other sectors like electronics, home improvement and clothing,” added Natarajan. 
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