physical distribution system

Physical distribution is the set of activities concerned with efficient movement of finished goods
from the end of the production operation to the consumer. Physical distribution takes place
within numerous wholesaling and retailing distribution channels, and includes such important
decision areas as customer service, inventory control, materials handling, protective packaging,
order procession, transportation, warehouse site selection, and warehousing. Physical distribution
is part of a larger process called "distribution," which includes wholesale and retail marketing, as
well the physical movement of products.

Physical distribution activities have recently received increasing attention from business
managers, including small business owners. This is due in large part to the fact that these
functions often represent almost half of the total marketing costs of a product. In fact, research
studies indicate that physical distribution costs nationally amount to approximately 20 percent of
the country's total gross national product (GNP). These findings have led many small businesses
to expand their cost-cutting efforts beyond their historical focus on production to encompass
physical distribution activities. The importance of physical distribution is also based on its
relevance to customer satisfaction. By storing goods in convenient locations for shipment to
wholesalers and retailers, and by creating fast, reliable means of moving the goods, small
business owners can help assure continued success in a rapidly changing, competitive global
market.

A SYSTEM APPROACH

Physical distribution can be viewed as a system of components linked together for the efficient
movement of products. Small business owners can ask the following questions in addressing
these components:

 Customer service—What level of customer service should be provided?

 Transportation—How will the products be shipped?
 Warehousing—Where will the goods be located? How many warehouses should be
utilized?
 Order processing—How should the orders be handled?
 Inventory control—How much inventory should be maintained at each location?
 Protective packaging and materials handling—How can efficient methods be developed
for handling goods in the factory, warehouse, and transport terminals?

These components are interrelated: decisions made in one area affect the relative efficiency of
others. For example, a small business that provides customized personal computers may
transport finished products by air rather than by truck, as faster delivery times may allow lower
inventory costs, which would more than offset the higher cost of air transport. Viewing physical
distribution from a systems perspective can be the key to providing a defined level of customer
service at the lowest possible cost.

CUSTOMER SERVICE
Customer service is a precisely-defined standard of customer satisfaction which a small business
owner intends to provide for its customers. For example, a customer service standard for the
above-mentioned provider of customized computers might be that 60 percent of all PCS reach
the customer within 48 hours of ordering. It might further set a standard of delivering 90 percent
of all of its units within 72 hours, and all 100 percent of its units within 96 hours. A physical
distribution system is then set up to reach this goal at the lowest possible cost. In today's fast-
paced, technologically advanced business environment, such systems often involve the use of
specialized software that allows the owner to track inventory while simultaneously analyzing all
the routes and transportation modes available to determine the fastest, most cost-effective way to
delivery goods on time.

TRANSPORTATION

The United States' transportation system has long been a government-regulated industry, much
like its telephone and electrical utilities. But in 1977 the deregulation of transportation began
with the removal of federal regulations for cargo air carriers not engaged in passenger
transportation. The deregulation movement has since expanded in ways that have fundamentally
altered the transportation landscape for small business owners, large conglomerates and,
ultimately, the consumer.

Transportation costs are largely based on the rates charged by carriers. There are two basic types
of transportation rates: class and commodity. The class rate, which is the higher of the two rates,
is the standard rate for every commodity moving between any two destinations. The commodity
rate is sometimes called a special rate, since it is given by carriers to shippers as a reward for
either regular use or large-quantity shipments. Unfortunately, many small business owners do not
have the volume of shipping needed to take advantage of commodity rates. However, small
businesses are increasingly utilizing a third type of rate that has emerged in recent years. This
rate is known as a negotiated or contract rate. Popularized in the 1980s following transportation
deregulation, contract rates allow a shipper and carrier to negotiate a rate for a particular service,
with the terms of the rate, service, and other variables finalized in a contract between the two
parties. Transportation costs vary by mode of shipping, as discussed below.

TRUCKING—FLEXIBLE AND GROWING The shipping method most favored by small

business (and many large enterprises as well) is trucking. Carrying primarily manufactured
products (as opposed to bulk materials), trucks offer fast, frequent, and economic delivery to
more destinations in the country than any other mode. Trucks are particularly useful for short-
distance shipments, and they offer relatively fast, consistent service for both large and small
shipments.

AIR FREIGHT—FAST BUT EXPENSIVE Because of the relatively high cost of air transport,
small businesses typically use air only for the movement of valuable or highly-perishable
products. However, goods that qualify for this treatment do represent a significant share of the
small business market. Owners can sometimes offset the high cost of air transportation with
reduced inventory-holding costs and the increased business that may accompany faster customer
service.
WATER CARRIERS—SLOW BUT INEXPENSIVE

There are two basic types of water carriers: inland or barge lines, and oceangoing deep-water
ships. Barge lines are efficient transporters of bulky, low-unit-value commodities such as grain,
gravel, lumber, sand, and steel. Barge lines typically do not serve small businesses. Oceangoing
ships, on the other hand, operate in the Great Lakes, transporting goods among port cities, and in
international commerce. Sea shipments are an important part of foreign trade, and thus are of
vital importance to small businesses seeking an international market share.

RAILROADS—LONG DISTANCE SHIPPING Railroads continue to present an efficient mode

for the movement of bulky commodities over long distances. These commodities include coal,
chemicals, grain, non-metallic minerals, and lumber and wood products.

PIPELINES—SPECIALIZED TRANSPORTERS

Pipelines are utilized to efficiently transport natural gas and oil products from mining sites to
refineries and other destinations. In addition, so-called slurry pipelines transport products such as
coal, which is ground to a powder, mixed with water, and moved as a suspension through the
pipes.

INTERMODAL SERVICES Small business owners often take advantage of multi-mode deals
offered by shipping companies. Under these arrangements, business owners can utilize a given
transportation mode in the section of the trip in which it is most cost efficient, and use other
modes for other segments of the transport. Overall costs are often significantly lower under this
arrangement than with single-mode transport.

Of vital importance to small businesses are transporters specializing in small shipments. These
include bus freight services, United Parcel Service, Federal Express, DHL International, the
United States Postal Service, and others. Since small businesses can be virtually paralyzed by
transportation strikes or other disruptions in small shipment service, many owners choose to
diversify to include numerous shippers, thus maintaining an established relationship with an
alternate shipper should disruptions occur. Additionally, small businesses often rely on freight
forwarders who act as transportation intermediaries: these firms consolidate shipments from
numerous customers to provide lower rates than are available without consolidation. Freight
forwarding not only provides cost savings to small businesses, it provides entrepreneurial
opportunities for start-up businesses as well.

WAREHOUSING

Small business owners who require warehousing facilities must decide whether to maintain their
own strategically located depot(s), or resort to holding their goods in public warehouses. And
those entrepreneurs who go with non-public warehousing must further decide between storage or
distribution facilities. A storage warehouse holds products for moderate to long-term periods in
an attempt to balance supply and demand for producers and purchasers. They are most often used
by small businesses whose products' supply and demand are seasonal. On the other hand, a
distribution warehouse assembles and redistributes products quickly, keeping them on the move
as much as possible. Many distribution warehouses physically store goods for fewer than 24
hours before shipping them on to customers.

In contrast to the older, multi-story structures that dot cities around the country, modern
warehouses are long, one-story buildings located in suburban and semi-rural settings where land
costs are substantially less. These facilities are often located so that their users have easy access
to major highways or other transportation options. Single-story construction eliminates the need
for installing and maintaining freight elevators, and for accommodating floor load limits.
Furthermore, the internal flow of stock runs a straight course rather than up and down multiple
levels. The efficient movement of goods involves entry on one side of the building, central
storage, and departure out the other end.

Computer technology for automating warehouses is dropping in price, and thus is increasingly
available for small business applications. Sophisticated software translates orders into bar codes
and determines the most efficient inventory picking sequence. Order information is keyboarded
only once, while labels, bills, and shipping documents are generated automatically. Information
reaches hand-held scanners, which warehouse staff members use to fill orders. The advantages of
automation include low inventory error rates and high processing speeds.

INVENTORY CONTROL

Inventory control can be a major component of a small business physical distribution system.
Costs include funds invested in inventory, depreciation, and possible obsolescence of the goods.
Experts agree that small business inventory costs have dropped dramatically due to deregulation
of the transportation industry.

Inventory control analysts have developed a number of techniques which can help small
businesses control inventory effectively. The most basic is the Economic Order Quantity (EOQ)
model. This involves a trade-off between the two fundamental components of an inventory
control cost: inventory-carrying cost (which increases with the addition of more inventory), and
order-processing cost (which decreases as the quantity ordered increases). These two cost items
are traded off in determining the optimal warehouse inventory quantity to maintain for each
product. The EOQ point is the one at which total cost is minimized. By maintaining product
inventories as close to the EOQ point as possible, small business owners can minimize their
inventory costs.

ORDER PROCESSING

The small business owner is concerned with order processing—another physical distribution
function—because it directly affects the ability to meet the customer service standards defined
by the owner. If the order processing system is efficient, the owner can avoid the costs of
premium transportation or high inventory levels. Order processing varies by industry, but often
consists of four major activities: a credit check; recording of the sale, such as crediting a sales
representative's commission account; making the appropriate accounting entries; and locating the
item, shipping, and adjusting inventory records.
Technological innovations, such as increased use of the Universal Product Code, are contributing
to greater efficiency in order processing. Bar code systems give small businesses the ability to
route customer orders efficiently and reduce the need for manual handling. The coded
information includes all the data necessary to generate customer invoices, thus eliminating the
need for repeated keypunching.

Another technological innovation affecting order processing is Electronic Data Interchange. EDI
allows computers at two different locations to exchange business documents in machine-readable
format, employing strictly-defined industry standards. Purchase orders, invoices, remittance
slips, and the like are exchanged electronically, thereby eliminating duplication of data entry,
dramatic reductions in data entry errors, and increased speed in procurement cycles.

PROTECTIVE PACKAGING AND MATERIALS HANDLING

Another important component of a small business physical distribution system is material

handling. This comprises all of the activities associated with moving products within a
production facility, warehouse, and transportation terminals. One important innovation is known
as unitizing—combining as many packages as possible into one load, preferably on a pallet.
Unitizing is accomplished with steel bands or shrink wrapping to hold the unit in place.
Advantages of this material handling methodology include reduced labor, rapid movement, and
minimized damage and pilferage.

A second innovation is containerization—the combining of several unitized loads into one box.
Containers that are presented in this manner are often unloaded in fewer than 24 hours, whereas
the task could otherwise take days or weeks. This speed allows small export businesses adequate
delivery schedules in competitive international markets. In-transit damage is also reduced
because individual packages are not handled en route to the purchaser.