Impact of slow steaming on shipper’s inventory /
Bachelor Thesis /
Name: ThetWai Lynn Htut
Student number: 357719
Supervisor: Martijn Streng
Submitted on: 29.08.2014
Abstract
“Slow steaming started becoming de rigeur in 2007”(Visser, 2010). Container ships are now operating at a lower speed than maximum: between 18 knots and 20 knots. Carriers benefit from slow teaming due to reduced fuel costs and elimination of vessel overcapacity. On the other hand, shippers are forced to reconfigure their supply chain and manage their inventory due to longer transit time.
This research paper studies the impact of slow steaming from a shipper’s perspective with the main focus being on the inventory management. The research question “what is the impact of slow steaming on shipper’s inventory” is answered by making a comparison between theory from existing literature and interviews with EVO, a shippers’ organization and a shipper. The result shows that longer transit time due to slow steaming causes shippers to manage their inventory levels in order to meet the demand of the end customer. This entails increase in inventory cost as well as capital expense for having to keep additional inventory. Shippers using Just In Time model are mostly affected and in practice, to respond to long transit time shippers in reality set safety stock according to a mixture of 3 approaches: time supply, shortage costing and service level approach.
Table of Contents
Introduction4
Literature review6
Impact of slow steaming on various parties6
Inventory management8
The effect of slow steaming on shipper’s inventory12
Measures taken by shippers to accommodate longer transit time13
Data & methodology15
Combining theory and practice18
Conclusion21
Recommendations for further resarch and Limitations22
BIBLIOGRAPHY23
APPENDIX 126
APPENDIX 229
- Introduction
Due to technological advancement in the maritime industry together with growth in the world trade, speed has become the most important factor in maritime transportation. For shippers, the use of a larger and faster ship sailing at 25knots guarantees faster delivery time (added value of the goods being delivered), lower inventory costs and higher trade volume per unit time (Psaraftis, 2012). However, ships began to sail at a reduced speed known as slow steaming and according to Visser (2010), “slow steaming started becoming de rigeur in 2007”. Slow steaming can be defined as operating ships at a lower speed than maximum: between 18 knots and 20 knots instead of the standard speed which varies between 20 knots and 25 knots. This practice has been adopted by container ships since 2008 as a response to increasing fuel prices and falling demand for transportation capacity (Wiesmann, 2010). According to Fagerholt, bunker fuel accounts for 50% of the vessel operating cost and this cost is proportional to the ship’s speed hence, the only cost saving way for a ship owner against high bunker prices would be to reduce the engine speed of the ship (Fagerholt, 2010).
Since then, there have been various researches done on slow steaming. For example, Maloni et al. (2013) illustrates that combined carrier and shipper costs reduce when speed is loweredloweredfrom full to slow then extra slow steaming. The research also finds that sailing ships at extra slow speed of 18 knots reduces carbon dioxide emissions by 43 percent and moreover it is the best vessel speed regardless of future volumes or fuel prices. Cariou (2011) asks the question of whether slow steaming of container ships is a sustainable way to reduce carbon dioxide emissions and if so, at what bunker break-even price. The result shows that carbon dioxide emissions reduction can be sustained only if bunker price is between $350 and $400. On the other hand, paper by Kontovas and Psaraftis (2010) examines the effect of slow steaming on modal split and findings show that shippers of slow travelling cargo may use a different transport such as land-based modes if their inventory costs are huge. Faber et al (2010) reveals that 30 percent of carbon emission can be reduced in the future if tankers, bulk and container ships continue slow steaming the same way as of 2007.
This paper will study slow steaming solely from the perspective of the shippers because the existing literature presents the general audience with a bias that slow steaming is completely beneficial for all parties where in fact, limited researches which ceased to exist reveal that it is not the case for shippers. Secondly, this paper aims to add value and draws more attention towards the claim made by Streng (2012): “The costs for shippers and consignees are most of the times higher than the possible benefits for carriers”. The main focus of this paper will be on shipper’s inventory management in response to slow steaming as this paper strives to emphasize more on the claim of how “shippers are potential supply chain losers with added inventory costs” (Hailey,2013). After mentioning the social and scientific relevance of the research, the research question is formulated as:
“What is the impact of slow steaming on shipper’s inventory?”
First of all within the literature review, an overview of the consequences of slow steaming for carriers and shippers will be briefly reviewed. Secondly, general inventory management models will be discussed together with the definition of inventory and reasons for firms to hold inventory. Then by making use of existing research literature, the impact of slow steaming on shippers with regards to inventory management will be discussed together with what kind of measures they take to deal with inventorieswith regards to slow steaming. This research is of qualitative kind and data will consist of interviews with EVO and a shipper. These parties should provide practical insights into inventory management of shippers with regards to slow steaming. Based on the inventory control methods discussed in literature and the answers from interview with the shipper, a comparison will be made on how slow steaming influences shippers’ inventory levels according to theory and according to a number of practical cases. Lastly, concluding remarks, including limitations of this paper together with recommendations for further research will be stated.
- Literature review
Impact of slow steaming on various parties
Container shipping supply chains consists of various actors. Some of these links do face consequences of slow steaming according to literature, while others only have to take slow steaming into account, rather than factually having to face consequences. The main parties that face consequences according to literature are shippers, consignees and carriers. Within this research, shippers and consignees are considered together, since it is difficult to differentiate and divide the consequences between the two.
Carriers
First of all, carriers enjoy significant benefits from slow steaming via savings in fuel costs. There is an exponential relationship between fuel consumption and sailing speed. Therefore by reducing speed, bunker fuel usage is decreased resulting in vessel operation cost for vessels (Fagerholt, 2010). A recent study conducted by DNV shows that a 24% speed reduction (from 25 knots to 19knots) results in 30% fuel savings for carriers (Bergh, 2010). Wiesmann (2010) also finds that fuel savings can amount to 58 percent when ships reduce their speed from 27 knots to 22 knots.
Secondly, by slow steaming their vessels, carriers benefit from reduced carbon emissions which are harmful to the environment. Three tons of carbon dioxide emissions are reduced for every ton of fuel saved (Wiesmann, 2010). Faber et al (2010) predicts that reduction of carbon emissions can be sustained by 30percent reduction in coming years ships continue to slow steam. Cariou (2011) finds that if ships are to sail at 18 knots (extra slow steaming), carbon dioxide emissions can be reduced by 43 percent. This reduction in emissions can be used for various purposes, including marketing strategies.
Although additional costsare imposed on carriers because they have to invest in additional vessels due to slow steaming, slow steaming helps carrier fight against over-capacity. Wiesmann (2010) states that 450 containerships and 800 merchant ships had been added to existing vessel fleet in 2010 due to slow steaming in order to keep up with cargo schedules, assuming frequency remains similar under slow steaming conditions. Although this poses in an increased costs for carriers, in the end these costsareovercome by the benefits they reap from reduced fuel consumption and abolishing overcapacity of idle or laid up vessels.
Shippers
Shippers on the other hand face substantial costs due to slow steaming. Their products take longer to arrive at their destination due to vessels sailing at slower speed. More specifically, reducing vessel speed from 27 knots to 22 knots lengthens the transit time by 3 to 4 days on a voyage from Asia to Europe. (Wiesmann,2010). This entails various costs to shippers. First of all, due to longer transit time, shippers experience increased costs due to depreciation and holding inventory (Hummelset al.2012). Streng (2012) finds that due to longer transit time, insurance, interest and depreciation costs increases. Moreover, shippers who deal with slow travelling cargo are forced to find different means of transport such as land modes because the inventory costs are increased to a considerable amount (Kontovas and Psaraftis, 2010). Maloni (2013) also finds that due to longer transit time, shippers will have to increase their holding inventory in order to maintain their delivery schedule to end customers and to prevent losing sales or breakdown in production. Hence, slow steaming forces shippers to reconfigure their whole supply chain; most importantly their inventory level. This paper will study the impact of slow steaming on shipper’s inventory; specifically how shippers control their inventory prior to and after slow steaming.
Inventory Management
In order to determine how slow steaming influences inventories and how shippers had to adjust their inventory management, it is important to obtain a basic insight into inventory management. Therefore inventory management concepts will be discussed, in order to carry out a decent comparison later on. A brief definition of inventories is followed by the reasoning behind holding inventories. Final section discusses what kind of inventory models can be applied by shippers.
Inventory
A simple way to understand the meaning of inventory is a stock of goods. According to Ballou(2004), inventories can be defined as “stockpiles of raw materials, suppliers, components, work in process, and finished goods that appear at numerous points throughout a firm’s production and logistics channel”. On the other hand, Dilworth defines inventory as idle resources within the firm that is being held to be used in the future whenever firm’s input or output is not used as available (Dilworth,1999).
Reasons for holding inventory
According to Lysons and Farrington (2012), a firm may hold inventory mainly for five reasons:
- Reducing risk of supplier failure and uncertainties: firms keep buffer stock in case the suppliers fail to fulfill the delivery of goods and in case of unforeseeable breakdown within the supply chain such as transport failure, strikes and similar factors.
- Protecting against lead-time uncertainties: investment in safety stock is crucial if the firm’s suppliers do not provide stock refill or lead-time with certainty.
- Preparing against demand uncertainties: seasonal demand influences firms to accumulate inventory and if the firm manufactures to stock, it can keep a constant level of production throughout the year.
- Taking advantage of quantity discount: economies of scale can be achieved in the form of quantity discount when purchases are made in bulk.
- Protection against shortages and inflation: inventory allows firm to continue serving its customer at a full service level even in times of shortages or price increases
Inventory system and inventory management
An inventory system is a protocol or policies used by firms to keep track and manage their inventories. To be more precise, it monitors the inventory and allows the firm to establish the levels that it should maintain, when stock should be replenished and the size of new orders (Chase, Jacobs and Aquilano, 2010).
The main function of an inventory management is to establish the level of each inventory items a firm should hold in stock together with determining the time and size of the order a firm should place (Brigham and Gapenski, 1997). Without proper inventory management, a firm will either have an unwanted high inventory levels that entails cost of holding or a low level that is unable to accommodate the firm to function in a optimum way.
Determining the level of inventory
Different inventory models are used to determine the level of goods a firm holds in inventory and to make sure that demand for these goods is met. The models are designed to convey the firm about two main issues: time when the firm should place the replenishment order and the quantity of order (Waldmann, n.d.).
Jacobs and Aquilano (2010) mentions two type of inventory management systems namely fixed-order quantity models and fixed-time period models.
Fixed-order quantity models (Economic Order Quantity or Q-model)
In this inventory model, the order amount is fixed and the actual ordering occurs when the level of inventory in the firm drops below a certain point. In other words, when the level of inventory available in the firm reaches point R, an order of size Q is made by the firm. The assumptions of the model is as follows:
- Demand for product, lead time, price per unit and ordering costs are constant
- Cost of holding an inventory is dependent on average inventory
- Backorders are not permitted
- The firm will satisfy all demands for the product.
Source: Jacobs. F R, Chase.R B and Aquilano.N J. 2010. Operations and Supply Chain Management: 366
The above figure illustrates that when inventory level is below point R, a reorder is made by the firm, which is received at the end of period L. The mathematical equation to find Q is as follows:
Q= quantity of the order a firm places
D= annual demand
S= ordering cost
H= cost per unit of holding an inventory
Point of reorder R can be found:
R= point of reorder
= average daily demand
L= Lead time (in days)
Fixed-time period models (P-model)
In this fixed-time period system, the firm counts its inventory at particular time and places order quantities that vary from time to time according to how much inventory is used. The problem that is posed by this model is that inventory is counted only at fixed time so the inventory can be depleted if the firm faces a large demand. Hence, safety stock is needed in order to prevent the firm from facing stock out during the period of inventory review as well as during the lead-time.
Just In Time (JIT)
According to Biggart and Gargeya (2002), Just In Time inventory system also known as zero inventory is based on the 3 philosophies: eliminating waste (inventory), constant improvement on quality of products and full employee participations in planning and execution. However, when the firm uses JIT inventory management, it must ensure a close-knit relationship with its suppliers and transportation providers so that required goods arrive at a precise time they are needed for production. If either party fails to perform the required task of delivering the goods to the firm, there will be a breakdown in the whole supply chain as there will be no safety stock to accommodate for the delayed or lost goods (Gourdin, 2005).
Whether the effect of slow steaming depends on what kind of inventory model is applied by shippers, is one of the issues this thesis aims to find out. It is important first to state how slow steaming influences inventories in general.
The effect of Slow Steaming on shipper’s inventory
Transit time
According to Harrison and Fichtinger (2013), transit time in a shipping environment can be defined as “the number of sailing days on a port-to-port (P2P) basic”. Hence, ocean transit time is the time the ship takes to sail from the quay departure to the point ship is quayside. For maritime transport, transit time is a very important factor for shippers because offering short transit time to the end customer in the supply chain gives the shipper a competitive edge over other shippers.
Impact of longer transit time on shipper’s inventory management
The two key factors for shippers when using liner shipping as a means of transporting are: costs per unit and high schedule reliability with short transit times (Notteboom, 2006). This is because a poor performance or any disruptions in transit time impact the inventory of the firm. According to Hummels et al (2012), due to a change in arrival of goods due longer transit time, both capital costs of goods in transitas well as costs of holding safety inventory increases. In other words, due to slow steaming, shippers incur higher in-transit inventory costs.
Little’s law of inventory queuing of (Little, 1961) suggests that longer transit time causes an increase in pipeline inventories if transportation speed remains the same. Pipeline inventories are goods that are in transit state after leaving the shippers and before reaching the consignee. Furthermore, Little reveals that due to an increase in pipeline inventories, more capital is tied up in the firm in order to meet the same level of demand and due to longer transit time, firms must increase their safety stocks (Little, 1961).
According to National Industrial Transportation League (2011), slow steaming causes shippers to readjust their whole supply in order to accommodate the fluctuations in inventory. Shippers have been forced to increase their inventory level at a higher cost to adjust for longer transit time. If vessels slow down from 25 to 19knots, shippers increase their safety inventory by 10 percent in order to ensure that the same level of products are supplied to their end customers (Bergh, 2010). Similarly, Maloni (2013) also finds that in order for shippers to maintain their delivery schedule, shippers will have to increase their holding inventory.