When risk minimization becomes a risk in logistics

Logistical decisions are ultimately economic decisions. This applies, for example, to major investments in warehouse and conveyor technology. Once all possible technical, informational and organizational questions have been clarified, managers in logistics and supply chain management must make a choice between two or more investment alternatives on the basis of economic considerations. But what is the right approach to the economic selection of (competing) investment alternatives – for example between packing station A and packing station B? Are there rational rules for this? Or is this a subjective decision? Is it a gut feeling which ultimately decides? Let’s take a closer look:

Strategy of investment decisions

Decisions for or against a particular investment alternative are typically multi-stage, i.e. “strategic”:

(1) Of two alternatives with the same capital requirement, the one with the highest return is the more economical investment.

(2) Of two alternatives with the same rate of return, the one with the lower capital requirement is the more economical solution.

(3) The decisive factor for the preference of an investment is therefore -due to points (1) and (2) -not the absolute capitalized earnings value, but the relative capitalized earnings value.

(4) The investment alternative with the highest expected relative capitalised value is therefore the most economical solution.

Minimized risk – decisive for investment?

In the practice of logistics management and logistics controlling the return on investment period – ROI – is included in the decision to assess investments in warehouse and conveyor technology in addition to the return on investment. After the return on investment, the payback period is therefore an additional evaluation criterion that allows the risk to be taken into account when making an investment decision. The following considerations are – possibly – useful for this purpose:

(5) If two investment projects have the same return, the one with the shorter payback period has the lower risk and is therefore preferable.

(6) If two investment projects have the same payback period, the risk is the same and the investment with the higher return is the most economical solution.

(7) For two investment projects with the same service life and the same return, the payback period is the same and the ROI is not an additional selection criterion.

 

This the basis for the general investment strategy of yield maximization with risk limitation (according to Timm Gudehus):

“Investments are to be realized in the order of decreasing returns if the returns are the same they should be implemented in the order of increasing amortization time…”

The time trap

The management strategy of risk minimisation that can be observed in most companies is that investments with a shorter payback period are carried out with priority and only projects with an ROI below a specified threshold (target value) of, for example, 3 or 5 years are considered. This often leads to the fact that the most profitable investments in the medium and long term no longer appear on the “radar”. Unternehmen mit reiner Risikominimierung fallen damit gegenüber anderen Unternehmen im Wettbewerb mittel- und langfristig zurück, die Investitionen primär nach der Rendite entscheiden und den ROI erst nachrangig berücksichtigen. In the medium term and long term companies with pure risk minimization thus fall behind other businesses, which primarily decide on investments on the basis of returns and take ROI into account only to a lesser extent.

The originally intended strategy of risk minimization can thus be reversed. The permanent short-term orientation of investments – for example in warehouse and conveyor technology – thus leads to short-term optimisation due to the exclusion of advantages that lie further in the future. The terms “quick wins” and “low hanging fruits”, that are so popular in the consulting language, sound attractive, but are ultimately often the cause of the “time trap” in logistics and supply chain management described above.

Weitere Informationen zu Optimierungsstrategien finden Sie im Beitrag Further Information regarding optimisation strategies can be found in the article “Optimization via process chain management”.

About Peter Klement

Peter Klement

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