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Trade-offs and their economics

Cost-benefit analysis is a relatively straight-forward exercise for large discrete choices in natural resource supply chains such as transportation modes and site locations. When average or typical operations are well understood, the benefits of one choice over another can often be very one-sided, making the best choice obvious. However, we have found through the dynamic modelling of complex supply-chain logistics that many of the most impactful decisions relate to variability and are more continuous in nature. We call these decisions ‘trade-offs’ and evaluating them economically can help you optimise your investment once you have exhausted your present assets’ capabilities.

What is a trade-off?

A trade-off is a decision of ‘how much?’ or ‘how many?’, rather than ‘which one?’ or ‘go/no go?’ Here are just a few examples of trade-offs and the real economic risk they present if they are either too conservative or too aggressive: • Storage capacity: Insufficient storage capacity shuts in pipelines upstream and downstream, delays trains and ships, or forces plants to be shut down, resulting in millions of dollars in lost capacity or missed opportunity. However, additional tanks, stockyard lines, and storage buildings can cost upwards of $20 million each. How much storage capacity do you build? • Fleet size: Insufficient fleets underperform during surges in demand, resulting in missed deadlines, lost customers and unsustainable revenue. However, excessive fleet capacity is unnecessarily expensive: unit trains can cost $15 million each and chartering a ship can cost $50,000 per day. How many locomotives, railcars, and ships do you buy or lease? • Equipment redundancy: If you drive high utilisation on all of your processing assets, you will lose capacity and revenue every time there is a delay. Although installing spare equipment can mitigate these impacts, it can be wasteful andexpensive in the extreme. What baseline utilisation do you plan for? How many hot and cold spares can you justify? • Optimal inventory levels: Given fixed storage capacity, you have a choice of the average inventory level you keep. High inventory levels avoid shutting in downstream systems but frequently shut in upstream systems, and vice versa. Inventory carrying costs and the associated reduction in your working capital also need to be considered. How much inventory should you keep on average? Each of these decisions helps reduce the impact of expected variability from seasonal volume surges and unit loads (trains, batches and ships). Of course, weassume you have already tried to minimise unexpected variability due to breakdowns and unplanned delays. While seasonal and unit-load variability remain necessary in many supply chains, they can cause you less grief if you estimate how much to expect and invest accordingly.

Allen Funston, Consultant, Ausenco, Vancouver, Canada

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