Laxmi Transformers Introduction Case Context ‘The issue of mode choice for movement of both raw materials and finished products is taken up in this case. A mode choice problem is typically one of selecting among a small number of alternatives. However, it requires considerable skill to flesh out the detailed consequences of such choices. In fact, almost the entire gamut of logistical concerns (of transport costs, inventories, handling costs, service parameters, investment costs in setting up the logistical network, etc.) come into play in this case. In this case, itis possible to consider an integrated logistical arrangement to take care, partially at least, of both incoming raw material and despatch of finished goods. Each mode, rail, sea and road offers the possibility of its use for both inbound and outbound logistics, provided the required time synchronisation is present. Here, the location of the plant has already been decided, based on various considerations, such as the availability of natural gas as a fuel and access to new sponge iron plants in westem India. However, the market for the final product of Laxmi Transformers, viz. DRI (sponge iron) was a growing one in India and there is some scope at this point for focusing on some selected final markets. Logistics costs could form a significant factor in this consideration. Further, in this case, the distribution network has to be decided upon, depending on the mode choice. Each mode has some associated options as to the outbound movement of finished goods. The same is the case for the inbound movement of raw materials (for example, if ral is an option, there is a possibility of using rail up to a point and then moving by truck, and there is also the long-term possibility of financing the construction of a siding for connecting the plant to existing rail infrastructure). ‘The infrastructure, especially for inbound movement of raw materials, is yet to be installed, and before doing s0, it is crucial to analyse in sufficient detail the logistical consequences of each option. In this case, apart from transportation (freight) charges, the inventory and handling related costs (with due consideration of the appropriate value of the product at that point) are important factors.(Questions jor Liiscussion 1. What is the best mode for inbound logistic supply of raw material? 2. What final markets should Laxmi Transformers choose to serve based on logistical considerations? What is the best mode for the finished goods despatch to key markets? 3. Contingent on a particular choice for inbound movement, can the same mode be used for servicing some final markets? - 4. Is a rail siding from Pen to Alibag worth the investment? 5. If ships are to be used for inbound logistics, how many barges would be required for the lighterage operations from the mother vessel to the jetty at Alibag? 6. Would the scheduling of carriers in any mode affect the economics of the mode choice? Approach for Analysis In such a situation, attention must be paid to the value chain of the product, which could have a significant impact on inventory-related costs. In particular, inventory costs have to be calculated keeping in mind the stage at which the material is in, since raw material and finished goods have quite different values of holding and handling. The main quantities to be considered in inventory calculations for each mode are pipeline (or transit) inventories, batching inventories and buffer stock inventories. Each mode choice scenario has to be worked out with the relevant detail of all the associated costs. The sea mode, in particular has a number of cost factors, since the volume of movement is high enough as a result of which inventory costs while building up the loading quantity and while consuming the unloaded quantities have to be estimated. Also, barge costs have to be accounted for, with a suitable level of detail. Since the spatial spread of final markets for the firm is still uncertain, the logistics costs due toa mode choice decision may affect the choice of locations for marketing efforts, to some extent. In other words, while considering each mode of movement, the ‘optimal’ choice of markets to serve (with appropriate assumptions about marketshare) can be assumed. For this purpose, a segmentation of the final market can be done either on the basis of location of the customer or on the basis of size of the customer’s demand, in order to decide which markets to focus on. Recall that one of the motivations of locating the plant at Alibag was to serve new mini-steel plants and ferrous foundries in western India Case Text Laxmi Transformers (LT)* Direct reduced iron (DRI), commonly called sponge iron, was to be produced by Laxmi ‘Prepared by G. Raghuram and D. Mathew. Teaching material of the Indian Institute of Management, Ahmedabad, is prepared as a bass for class discussion, Cases are not designed to present illustrations of either correct or incorrect handling of administrative problems. Copyright © Indian Institute of Management, Ahmedabad.Transformers (LT) at their new Rs 500-crore Alibag plant in Maharashtra starting in February 1991. DRI is an intermediate product in the steel-making process and essentially serves as a substitute for scrap iron. DRI is used by both mini-steel plants and large integrated steel plants. It is also used by ferrous foundries. Maharashtra and Gujarat are the two most industrialised states in India and have a number of mini-steel plants and ferrous foundries, all potential sponge iron buyers. All the integrated steel plants are located in the eastern part of the country except the SAIL plant at Bhadravati in Karnataka. ‘The advantages of using sponge iron are as follows: 1. It is a substinite for ferrous scrap, which is currently imported in large quantities, costing the nation a large amount of foreign currency. 2. Undesirable elements, which may be found in scrap such as chromium, tin, nickel, etc. are absent. This gives a more consistent and reliable end-product quality. 3. It is easier to handle than scrap. Location The two primary reasons for locating the project at Alibag was the availability of natural gas and nearness to sponge iron markets. Natural gas from the Bombay High offshore field was brought to Uran by a pipeline, about 25 km due south of Bombay. Industries located in areas near Uran would get gas at what was called ‘landfall prices’, which were substantially less than what inland customers would pay. The landfall price of gas was about Rs 2,500 per 1,000 cubic metres. About 300 cubic metres of gas were needed per tonne of sponge iron. The project site was ‘on the seashore, with a view to having access to sea transport, both during construction and operations. There were a number of different processes that could be used for sponge iron production, some being coal based and some being gas based. In consultation with the engineering advisers to the project, Technocrats India Ltd., LT decided to adopt the HyL Ill process for sponge iron production, under license from the Mexican firm HyLsa that had patented it. This process used reformed natural gas to convert iron ore to sponge iron. The DRI plant, which had a. rated capacity of 5,00,000 tonnes per annum, would require about 1.24 tonnes of pellets per tonne of DRI and 0.31 tonnes of lump ore per tonne of DRI, making for a feed mix proportion of approximately 80 : 20. A problem with the Alibag plant was that the iron ore and pellets required were not available locally. Transportation T's newly appointed manager, logistics, decided that his first task would be to review the proposed transportation strategies of his company for the inward movement of raw mat and the outward movement of his company’s products. Raw Materials He first met the manager, raw material procurement (RMP), and then the manager, marketing, toget their views. The manager (RMP) was responsible for identifying potential reliable suppliers of the principal raw materials required namely, lump iron ore and iron pellets. He found that the ‘manager (RMP) had already made a thorough examination of the production situation and entered into contracts with three mines that would supply lump ore. The manager (RMP) had also entered into a long-term contract with Kudremukh Iron Ore Company Limited (KIOCL), Mangalore, for the supply of iron pellets, which was essentially produced by agglomerating fine particles of iron ore into pellets. Even though this was an export-oriented unit, whose rupee prices should ordinarily fluctuate according to the value ofthe rupee with respect to the US dollar, LT was able to negotiate a special arrangement, guaranteeing their requirements at the rate of Rs 600 per tonne fob. This rate would be reviewed annually. The manager (RMP) was able to clinch this deal because he negotiated at atime when KIOCL was going through a very troublesome period financially. Based on considerations, such as quality of ore and possible supply and handling constraints, LT had decided to procure lump ore in the following proportions from the mines mentioned below: Percentage Price (Reltonne) Daitari (Orissa) 40. 250 Banspani (Orissa) 40 250 Goa 20 330 ‘These sources were not substitutable, since they had been identified according to certain required chemical properties. Finished Goods ‘The manager, marketing, was in the process of trying to line up customers for LT’s DRI. While he had not yet been able to get any firm commitments, he had been able to make some estimates of the size of the market. A major difficulty he faced in this task was that while there were a few sponge iron producers in the country, none of them could be called major producers as due to various reasons they were producing at only a fraction of their capacity, The manager, marketing's, estimates of the market potential are shown in Exhibit 1. Inbound Mode Choice LT was now faced with the problem of deciding the best way of transporting the raw materials to the Alibag plant and the DRI from the plant to market centres. There were three possible modes that could be used—rail, road and sea or combinations of these three. Rail The nearest railhead to Alibag was at Pen about 15 km away. The Railway Board in Delhi had categorically stated that there was no prospect of the railways building a line to Alibag, but suggested that LT would be able to get a line constructed at their own expense at an approximatecost of about Rs 1 crore per km (including handling and storage infrastructure). If other industries, which were coming up in the area (cement bagging plant, a gas-based fertiliser plant, and a few others in the drawing board stage), wanted to use the track, LT would be able to share the construction costs. In the case of rail transport, freight rates were determined by the Indian Railway Conference [Association (IRCA), which published a book of tariffs. Exhibit 2 gives the relevant tariffs. While iron ore was classified as Category 110 for purposes of tariff determination, there was some confusion on the classification of DRI. While IRCA stated that sponge iron came under category 150, central railway’s commercial staff maintained that DRI was a different product and would be charged under category 210 Sea [A jetty capable of handling four barges simultaneously, with an unloading rate of 2,000 tonnes pet hour, was to be built at the plant site in Alibag. Giant Western Shipping had said that it would be able to provide two ships, one of 65,000 dead weight tonnes (dwt) and the other of 35,000 dwt. LT would be expected to pay market rates for whichever ship they decided to employ, as the shipping industry was riding on the crest of a wave. Going rates and details of ship operating costs and times are given in Exhibit 3 High tonnage ocean-going ships like the ones being considered could not enter Alibag’s minor port due to draught restrictions. Hence, cargo had to be loaded /unloaded in deep water into/ from barges which could use the jetty. Each barge could be used for one round trip in a day, due to the tidal variations. The current plan was to charter five barges of 1,000 tonnes payload capacity for this task. (The limits for unloading were determined by the operating rate of the cranes on the ship. A total of 10,000 tonnes per day was possible, but then 10 barges would be required. Five would be at the ship side when the other five were atthe jetty.) The charter rates for these barges were Rs 300 per tonne per month. Deep water operations at Alibag were not possible for 120 days of the year due to the monsoon. Road Road transport rates were expected to be 50 paise per tonne kilometre, though due to the new Motor Vehicles Act and consequent strict imposition of ‘no overloading’ the rates could possibly go as high as 70 paise per tonne kilometre Exhibit 4 gives a distance matrix between the various mines, Pen station, ports and market centres. Exhibit 5 gives a map of India with the relevant locations. Considerations for Outbound Movement In examining the options LT had regarding outbound movement, the following were some of the key issues that had to be borne in mind. 1. Since the ships that bring iron ore would be returning empty (being on a time charter), sponge iron to markets in the eastem parts of India could be transported by ship. This would involve additional time due to loading and unloading, but not due to travel time.EXHIBIT 1 Market Centre-wise Demand Estimate for Sponge Iron (10,000 tpa) No. Market Centre 1990-91 1995-96 2000-01 1 Delhi 8.8025 17.605 35.21 2 Hissar 1.0375 2.075 415 3. Ambala 0.885, 7 354 4 Ludhiana 3.8475 7.695 1539 5. Jaipur 2475 495 99 6 Lucknow 3.4325 6.865 1373 7. Muzaffamagar 17375 3.475 695 8 Tatanagar 2.0275 4.055 ail 9%. Ranchi 1175 235 47 10. —_Barajamda 0.0525, 0.105 021 .— Caleutta 10.705 2.41 4282 12 Rajkot 0.0525 0.105 021 13. Ahmedabad 0.845 169 338 14. Baroda 1.3075 2615 5.23 15. -Rajpur 17775 3.555 7 16. Gwalior 0.565 113 2.26 17. Indore 19125 3.825 7.65 18. Jabalpur 0.1825 0.365 073 19. Mumbai 937 18.74 3748 20. Nagpur 2.485 497 9.94 21. Aurangabad 035 07 14 22. Kolhapur 0.6775 1355 271 23. Waltair 0.8075 1615 3.23 24. Secunderabad 1:16, 232 4.64 25. Kothagudam 244 4.88 9.76 26, Bangalore 265 53 106 27. Hospet 05575 ans 223 28 —_-Bhadravati 148 2.96 592 29. Calicut 1275 255 51 30. Chennai 2.1175 4235 8.47 31. Tiruchirapalli 0.245 049 0.98 68.435 13687 273.74 32. Bhilai 20 25 30 33, Bokaro 20 30 35 34. Rourkela 9 u 8 35. Durgapur 8 9 u 36. Bumpur 5 5 6 37. TISCO, Jamshedpur 10 5 20 38 —VISL, Bhadravati 25 35 5 Total 142.935 238.37 395.74EXHIBIT 2 IRCA Tariff (Rs/quintal) Category 110 150 210 110 150 210 Km Km 1-100 4250544 724 M1350 1074 427 19.58 101-105, 454 5.82 777 351-360 ©1098 1459 2003, 106-110 465 599 799361370121 1491 2046 Mens 479 647 8213713801146 1523 2091 116-120 491 632 8453813901167 1555 21.36 121-125, 502 648 868 3914001191 15.87 21.80 126-130 54 665 a 4014101259 1678 23.06 131-135 526681 914 4120128 17.12 2352 136-140 538-698 937 421-430 13.08 17.43 2399 141-145 54974 959 BIO 1333 1778 2446 146-150 5617.29 984 481-450-1355 1811 492 151-155 5m 747 1005 451-460 13.80 18.44 25.38 156-160 587.64 1028 4611701405 1877 2584 161-165 5987.79 1os2 471-480 ©1430 19.10 2630 166-170 6797 1074 4814901454 1944 26.76 171-175 62 812 1097 491-500-1478 19.7 27.4 176-180 634 830 1120501510 15.66 20.96 2887 181-185 647843 1445115201591 21.28 2933 186-190 659861 1166 5218301613 2159 27 191-195, 671879 1190 531-540 16.38, 21.91 30.22 196-200 682 894 1125415501659 2.23 3067 201-205 7159.38 1273 551-560 1684 253 311 206-210 728 957 1298 = 5615701707 22.86 31.56 211-215 740 973 1321571580 1731 23.18 3199 216-220 753 991 1345581590 17.53 2350 3245 221-205 765 1007 1368 591-600 1777 2381 3290 778 1024 1392 6016101859 24.93 wad 791 1041 M415 611-620 18.84 25.26 3490 804 1058 440 621-690 19.07 25.58 35.36 241-245 8151074 46 631-640 19.32 2591 35.82 246-250 828 1092 1486 641-650 19.56 26.25 36.29 251-260 asl 1.22 1530 651-660 1981 2657 3673, 261-270 873154 1575 661-670 2004 26.90 3720 271-280 897 11.86 1619 671-680-2028 2723 37.64 281-290 9191218 1663 681-690 2052 2754 38.11 291-300 942 1248 1706 = 691-700-207 2790 3857 301-310 981 1299 1779 70-710 21.08 2834 3319 311-320 1005 13.82 18230 71-72 134 2867 3965, 321-330 1027 13.64 18677217380 2157 28.99 4012 331-40 10511395 1912737402181 2932 4058 (Contd)EXHUBIT 2 (Contd) Category no 150 10 10 150 210 kn Km 741-750 2208 2965 4106 1651-1675 43.60 59.02 8213 751-760 2997 4150 1,6761,700 44.06 59.61 82.95 761-70 3031 4197 1,701,725 44.65, 6043, 8413 71-780 3065 4244 1,726,750 45.10 61.04 84.96 781-790 3098 4289 751-1775 4552 61.62 85.76 791-800 3131 4336 1776-1800 4595, 6221 8657 80-825 3226 4469 1801-1825 4635, 6274 9734 826-850 33.09 4585 1826-1850 46,77 63.34 88.16 851-875 3392 4701 1851-1875 47.21 6391 8897 876-900 34.76 48.18 1876-1900 47.65 450 89.81 901-925 3571 4953 1,901-1,925 4795 492 90.42 926-950 2A 3655 5069 19261950 48.38, 6554 m3 951-975 mn 3738 51.86 1,951-1,975 48.81 66.12 92.07 976-1,000 2833 3822 5302 1,976.2,000 49.4 6669 + 92.88 1001-1025 28.96 39.06 5422 2001-2025 49.38, 66.90 93.15 1026-1,050 2949 39.78 5521 2026-2050 49.52 67.10 93.42 1051-1073 999 40.46 5618 2051-2075 49.91 67.60 944 1076-1100 3051 41.17 5716 2076.2,100 $0.28 68.10 9485 1101-1125 3113 42.03 5837 2101-225 50.64 68.61 95.55 1126-1150 31.66 42.75 59.36 21262150 51.01 69.13 9627 LASIAA7S = 3217 43.44 6035 2151-2175 51.39 6362 (96.98 1176-1,200 3269 44.13 6132 21762200 51.75 7013 97.67 120-1,225 3383.45.70 6350 2201-2225 5212 76s 98.39 1,226,250 34384642 6450 2,226.2950 5250 7115 99.11 1251-1275 3489 47.15 6549 2251-2275 5288 7164 9981 1.276100 35404784 6650 -2,276-2300 53.24 7215 10053, 1301-1325 36064873 6775 2301-2325 5361 ne 101.22 132613503659 49.46 6875 -2,326-2,350 53.98 7316 10193, 13511375 37125017 68.75 2351-2375 54.35, 7366 = 10263, 13761400 37.64 50.89 7075 2376-2400 54.72 7416 10335, 1401-1425 38.64 = 52.23 7264 2401-2450 55.45, 7518 10475 14261450 39175297 7366 2451-2500 56.21 7620 106.18 1451-1475 39.71 53.69 7468 2501-2550 56.84 7707 107.40 1476-1500 40.23 54.42 7569 2551-2600 57.49 7795 10862 1501-1525 4088 55.28 7690 5814 738310985, 15261550 4130 55.88 77 5877 me m107 LS5V-1575 41735645 7854 2701-2750 59.41 8056 11231 15761600 4213.57.04 7934 2751-2800 60.04 814611353, 1601-1695 4275.57.84 8050 2801-2850 6069 823311475 1626-1650 43.18 5844 8131 2851-2900 61.32 81911598EXHIBIT 3 Shipping Charges and Times Ship Size (dw) Payload (tonnes) Standing Charges US $ per day) (sper day) ‘One-way Voyage Fuel Costs tolfrom Alibag (Rs) Mormugao Loaded Ballast Mangalore Loaded —Balst Paradeep Loaded Blast Cateutta Loaded —Balast Fuel Costs at Anchor (Rs per day) Port Dues (Rs per entry) Alibag Mormugao Mangalore Paradeep Calcutta Unloading/Loading Charges (Rs per tonne) Alibag Mormugao Mangalore Paradeep Caleutta ‘Oneoway Average Travel Time tolfrom Alibag (days) Mormugao ‘Mangalore Paradeep Calcutta Average Waiting/Loading Period at Ports (days) Alibag (unloading) Mormagao Mangalore Paradeep Caleutta 35,000 34,000 9,000 153,000 120,000 108,000 180,000 157,500 8,40,000 735,000 960,000 8,40,000 15,000 3,00,000 3,36,000 330,000 3,80,000 420,000 8 50 FOBT 0 10 15 70 80 80 45 30 50 60 65,000 64,000 15,000 2,35,000 1,25,000 110,000 187,500 165,000 8,75,000 770,000 10,00,000 8,80,000 17,000 412500 462,000 453,750 5.22500 57300 10 15 75 85 110 35 60 70EXHIBIT 4 Distance Matrix (kilometres) Inbound Road and Rail Distances betwen Mines, Ports and the Plant Goa Mangalore Daitari Banspani Alibog oad) 520 800 1780 1,650 Pen aid 500" 70 2,200 1,800 Mormugao ‘ail 50 - - - Paradeep (Rai - = 170 700 400 (post 95) “After the completion of Konkan Railway (1996), Outbound Distances to Market Centres Town Pen Rail) ——_Alibag (Road) Town Pen (Rail) ——_Alibag (Road) Delhi 1420 1490 Baroda 0 510 Hissar 1520 1590 Raipur 140 1,200 Ambala 1,610 1.680 Gwalior 125 4170 Ludhiana 1685 1765 Indore 880 680 Jaipur 1,150 1250‘ Jabalpur 1,000 1130 Lucknow 1400 1450 Mumbai n 85 Muzaffaragar 1,550 1620 Nagpur 830 940 Tatanagar 1700 2,040 ‘Aurangabad? 300 350 Bhilai 1280 1450 Kolhapur 540 350 Rourkela 1340 1900 Wialtar 1320 1320 Durgapur 2,000 2,300 Secunderabad 810 80 Burnpur 1850 2250 Kothagudam 1,060 980 Bokaro 1820 2,200 Bangalore 1140 970 Ranchi 1650 2,000 Hospet 870 670 Barajamda 1,600 1,800 Bhadravati* 1390 780 Caleutta 1970 2.160 Calicut 1,840 1170 Rajkot 7380 850 Chennai 1290 1310 ‘Ahmedabad 540 630 Tiruchirapalli 1,710 1300 Towns marked * have metre gauge only.