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Home , Outsourcing

Analytical Model: Evaluating Incoterm Conversion

By Name(s) Mark C. Brown, Pratik Yadav Topic Areas: Sourcing, Strategy, Advisor: Dr. Bruce Arntzen

Summary: This capstone project investigates the various material buying arrangements that a buying entity will take on. The research will focus on a select group of products from a select group of suppliers. The suppliers selected will have different characteristics such as origin, volume, price, supplier relationship, etc. Total logistics costs and risk are included per incoterm option to give an overview to business managers on how to approach buying decisions. The result is a matrix of selected scenarios which will allow the buyer to understand the risk associated with each incoterm under a set of conditions and the expected cost difference.

Bio Bio Before coming to MIT, Mark Before coming to MIT, Pratik worked in product distribution worked in various areas of for several at companies like including U.S. Lumber, Maersk, DPDHL and lately Weyerhaeuser, and Georgia- ABB. He advised leading Pacific managing multiple companies on numerous departments including topics ranging from growth operations, transportation, strategy, supply chain

, and sales. He management, operations holds a BSci degree from the transformation to corporate / restructuring. He holds an MSc Knoxville. from Cranfield and BEng degree from University of KEY INSIGHTS Rajasthan

1. Having an active inbound spend and choice of shipper. This often results in management operation is critical in poor shipment status visibility and less control of taking advantage of an incoterm carrier selection for the buyer. Our research conversion strategy. evaluated the impact of using E&F compared to C&D incoterms on the overall logistics 2. Increased inbound visibility helps cost and risk for the . The visibility of the production planning reduce the need inbound freight is important because an accurate for higher safety stocks. ETA assists production planning. Better production planning lowers capital tied up in safety stock 3. Managed inbound allows for inventory. Considering all these challenges, the consolidation and backhaul company has requested an analytical model possibilities that will lower overall regarding the impact of incoterm choice regarding logistics cost. total logistics cost vs. risk. Some of the factors that we considered in the model are duties, taxes, material cost, supplier location, transport mode, lead time variability, inventory, and demand variability.

Introduction Incoterms are a set of commercial Methodology We used a structured methodology terms established by the International (Figure 1) approach which the main stakeholders Chamber of Commerce. Incoterms provide a from the sponsoring company are familiar with. framework of who pays for what and where the Short list t he responsibility of goods changes from seller to the Discuss t he Collect required Clean and business unit project with key data for the prepare the data buyer in the shipment process. For the purpose of and suppliers for st akeholders project for analysis this project we will classify incoterms into two capst one groups. The first group will consist of E & F type Develop the incoterms where the buyer will arrange freight. The Final Gen er at e Validat e t he model and recommendation insights and results conduct dat a second group will consist of C & D type incoterms & conclusion results and is based on the seller paying for transportation. analysis Current procurement strategy directs suppliers to buy mostly on C or D type incoterms. This strategy Figure 1: Project Methodology gives more control to the supplier on transport Our project was discussed with the business - Duties operations leadership who value the importance of evaluating opportunities within inbound logistics - Taxes management. Leadership is looking for a broad scope in terms of the number of sites, products, - Transportation suppliers, and the expected output. The agreed upon goal was to develop a model that can During the data collection it was observed that costs evaluate the cost and impact of using various such as the handling for inbound incoterms on different product categories. A shipments are miniscule compared to the transport preference matrix was developed to shortlist these and inventory costs; hence it was decided not to products used for analysis. The following criteria was used in selecting the suppliers and products Include them in the final data model. The model that would be analyzed for this research project. then calculated the total logistics costs per shipment - Are the suppliers willing to run a limited under common incoterms and the quantitative level scope pilot to test the validity of the results? of risk associated with each option. Some of the - Can the company representatives invest main challenges while collecting and analyzing the time and effort during the 8-month project data were to help collect data, validate the data analysis assumptions, review the draft - No central system existed where the data reports and help select scenarios for the could be extracted at once. Purchase order pilot setup? information was pulled from SAP, but - Can the project be completed within the shipment data was collected from multiple timeline required? sources including TMS and Excel. - Where are the suppliers based? Warehouse and handling costs were Preference would be given to suppliers that calculated based on primary interviews and are shipping products from multiple limited warehousing data. locations and using different modes of - Diverse set of values for data points such as transport such as ocean, rail, and air. This the cost of working capital used to range would allow the analytical model to be from 5% to 17% tested for various scenarios. - Lack of common consistent indicator to match purchase order information with Our model will focus on a selected set of 12 actual shipment/transport information. products as seen in Figure 2. - Limited and largely inaccurate information was available on actual pickup and delivery Agreed dates for shipments. Product Code Origin Destination Incoterm PRO00000001 CIP Beijing The risks were calculated using qualitative input via PRO00000002 China Sw it zerland DAP primary interviews with production planners, supply PRO00000003 China China DAP Beijing chain managers, and buyers. A rating of 1 to 5 was PRO00000004 China China DAP Beijing generated based on the responses with 5 being the

PRO00000005 China China DAP Beijing highest. The parameters used in calculating risk

PRO00000006 China China DAP Beijing were:

PRO0 0 0 0 0 0 0 7 China China DAP Beijing - Product country of origin PRO00000008 China Finland DAP

China FCA PRO00000009 - Product supplier past performance PRO00000010 China India FCA PRO00000011 Finland Multiple - Product cost PRO00000012 China Sw it zerland Multiple Figure 2: Product Under Scope - Strategic product or commodity product

We collected data for first quarter 2018 to calculate the total logistics costs. These costs included Results A decision matrix (Figure 3) was developed to help choose the best incoterm for a product - Purchasing category. Having an active inbound is critical in order to take full advantage - Ordering of converting incoterms from C&D terms to E&F terms. A full in-house management setup requires a - Inventory company to have a structured inbound team or may cause the need for more expensive air with an external provider to manage freight solutions) the inbound shipments. - Suppliers may not inform the buyer about shipment changes and details Purchase Nature of Inbound Operations Volume Origin Destination Proposed Incoterm Price Product Actively Managed 0-50 USD 0-10 0 0 0 Commodit y Eur op e Yes CPT/ DAP/ DDP E&F Type incoterms allow a company to enjoy 10 0 0 0 - 0-50 USD Commodit y Asia Eur op e Yes FCA/ FOB 10 0 0 0 0 increased visibility when the product is under the 0-50 USD 10 0 0 0 0 + Commodit y Asia Eur op e Yes FCA buyer’s control. Consolidated purchase volume is a 0-50 USD 0-10 0 0 0 Commodit y Asia Eur op e No DAP/ DDP

10 0 0 0 - possibility with E&F terms. A final possible benefit 0-50 USD Commodit y Asia Eur op e No FCA/ FOB 10 0 0 0 0

0-50 USD 10 0 0 0 0 + Commodit y Asia Eur op e No FCA could be delayed shipment invoicing as the shipper

50-200 USD 0-10 0 0 0 St r at eg i c Asia Eur op e Yes FCA can only bill for shipment when it is delivered 10 0 0 0 - 50-200 USD St r at eg i c Asia Eur op e Yes FCA 10 0 0 0 0 compared to when it ships. Based on the analysis, 50-200 USD 10 0 0 0 0 + St r at eg i c Asia Eur op e No FCA we have decided to not consider E terms as it Figure 3: Incoterm Selection Matrix includes the additional risk of goods getting loaded at the supplier site. Most of the goods with our The key benefits to having visibility and control of sponsoring company are larger in size and require inbound shipments to production sites are special loading equipment. A supply manager would not consider this as a value adding activity. - Better production planning thus reducing the Results from the research identify the need for higher safety stocks company incurring higher costs but gaining additional - Consolidation options on inbound shipments control of the inbound. This trade off is a relevant from multiple suppliers coming from the topic for companies that buy internationally and have same country/region high levels of working capital. - Increased carrier performance management with data Conclusion This research recommends evaluating - Backhaul potentials instead of one direction incoterms when purchasing to achieve the lowest flows total cost for the company. The purchasing decision also needs to evaluate the optimal visibility of arrival The key challenges to this setup include and understand the risk associated with each incoterm. This scenario is best achieved with in - Additional investment required for people house management of inbound logistics in most and systems cases. The next best option would be to use third- - Some may consider inbound not as party providers which manage the inbound on the important as outbound logistics company’s behalf using agreed on performance - Increased risk / liability for company metrics. Future research options could attempt to - Benefits sometimes take longer to show up verify the cost savings vs. the implicit risks - Suppliers may not be open to sharing data associated. Another research option could be to via interfaces compare the benefits and risks involved with managing inbound internally vs to a third One possible alternative to establishing an in-house party. Finally, there could be additional research inbound management setup is to work with a third regarding the implementation of this inbound party (3PL) or forth party (4PL) logistics service management strategy, these best practices could provider and allow them to manage the inbound then be applied to other industries that utilize operational activities. These responsibilities could international sourcing include

- Checking with suppliers to check if goods are ready to be picked up - Consolidate goods from the supplier to same end destinations - Conducting compliance checks on the customs declarations and material codes

Despite having several advantages such as lower cost of implementation and ease of rolling out service, 3PL/4PL does have several inherent disadvantages including

- Limited control on what services the suppliers can use with the carrier (delays