Supply Chain Digest’s Dan Gilmore recently spoke with Dr. David Simchi-Levi of MIT and an IBM Contractor, to discuss the impact of Sustainability on supply chain network design.
Gilmore: How big an impact do you think carbon emissions concerns will ultimately have on supply chain network design?
Simchi-Levi: The focus on Green logistics is driven by three factors. First, sustainability has moved to the heart of business with green logistics playing an important role.
Second, governments are increasingly taking unilateral legislative steps to force compliance. The Kyoto Protocol has set loose national targets but the European Union’s Emissions Trading Scheme - EU ETS – has taken the lead, mostly in Europe, in strongly regulating emissions allowances. Finally, consumer concern is starting to translate into a real need for new product and services. This stakeholder pressure is not just being felt from consumers, but also employees, partners and governments who are demanding that business take tangible steps towards becoming more “Green.” Such pressures are pushing the issue of carbon footprint up the business agenda.
However, logistics is a large and growing emitter of carbon dioxide. It contributes about 5.5 percent of the total greenhouse gas emissions generated by human activities, with transportation being responsible for 89 percent and the rest attributed to warehouses and distribution facilities. Within the transportation sector, road freight is responsible for more than half of the carbon dioxide emitted by the transportation sector, ocean is responsible for 20 percent, with rail and air for the rest. Of course, different modes of transportation have different emission efficiency. For example, truck carriage generates about six times the carbon emissions of rail to move the same level of freight.
Given this data, it is not surprising that significant opportunities exist to reduce carbon footprint across the entire supply chain, from raw materials through manufacturing all the way to distribution and home delivery. These opportunities involve changing the structure of the logistics network; more efficient recycling strategies; and government regulations and incentives. So in short, reducing carbon emission will require significant changes to the structure of the logistics network.
Gilmore: Are you seeing it now, even before cap and trade or a carbon tax?
Simchi-Levi: Yes! In particular, in Europe, where the Kyoto agreement provides financial incentives (through cap and trade) to companies to reduce carbon footprint. But this is not only the case in EU; we have customers which have applied IBM ILOG LogicNet Plus (our network design tool) to find the right trade-off between cost, service and carbon emission both in the US and globally. For example, Fonterra, a large Australian dairy cooperative, has made carbon emissions an important part of its supply chain network design.
Gilmore: What happens when we get either of the above? Does it matter which one we get?
Simchi-Levi: There is a big difference between the two and it does matter which one is implemented. The advantage of cap and trade is that it measures carbon at the aggregate level and it does not care which company reduced carbon emission as long as the total (aggregate level) achieves the desired impact.
The disadvantage of cap and trade is that carbon permit price is determined by the market and so decision makers face significant levels of uncertainty when they make decisions on whether to reduce carbon footprint below the cap and trade in the market or whether to violate the cap and purchase permits. The second problem with cap and trade is that implementation is difficult. For example, the government needs to decide how to initially allocate the permits and it may generate (unintentionally) an incentive to some companies with an initial allocation of permits to trade their permits and realize significant profit. They can do this without producing anything, benefiting from market price, rather than productive activities.
These problems do not exist when a carbon tax is implemented. This is true since tax rates will be known in advance and there is nothing that companies can sell in the market to generate windfall profit.
Unfortunately a carbon tax does not look at the aggregate level of emissions and hence does not take advantage of situations when some companies reduce carbon footprint significantly and hence perhaps others do not need to do the same.
Gilmore: How will network design tools such as that offered by IBM really factor this into the optimization models?
Simchi-Levi: The idea is straight forward. We incorporate information on carbon emission associated with every supply chain activity and take carbon footprint into account either as a constraint, or as part of the objective function. In short it allows the optimizer to identify the trade-off between cost, service and carbon footprint, and look at various scenarios in terms of different network options.
Gilmore: Isn’t accurately measuring/estimating carbon emissions going to be a real challenge? What can be done?
 Simchi-Levi: This is true. In the EU, where the Kyoto agreement has been implemented, companies reducing carbon footprint go through an audit to verify their claims. At IBM, we have developed a substantial carbon emissions database that provides information on carbon emission by such areas as carbon emissions by fuel type, average fuel efficiency values, carbon-freight factors for waterborne and rail, and electricity emissions factors by US state, and country.
This is important since carbon emission per kilowatt hour is different from state to state due to different power generation technology such as grid electricity, natural gas, diesel, petrol, coal, etc. Also, we include electricity consumption by building characteristics including building size, geographic region, number of workers, principal activity, year constructed, etc.
Gilmore: Do you have any sense yet as to how big a change this will make in the optimal networks for some companies? Would it possibly promote nearshoring, for example, or more production outsourcing? More or fewer DCs?
Simchi-Levi: This can make a big impact, much like the impact that high oil price has on the network. The tighter the cap on carbon emission, (1) the more DCs you need (to reduce outbound transportation costs); (2) the more emphasis on efficient packaging to reduce transportation; (3) the more move from air to sea and from truck to rail (since these two modes are more efficient from a carbon footprint point of view).
Will Green Supply Chain considerations be an increasingly important component of network design? Have you already started to consider this in network design analalyses? Let us know yoiur thoughts at the Feedback button below.
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