Draft Report(the Full One)

(Globalization and reaping scale advantages by centralizing logistics) The paradox is Globalization. Word counts excluding front matter, references and appendices is 2500.

Summary The purpose of this report is to highlight achieving economies of scale by centralising logistics, specifically, by centralising distribution system. It also shows the way of moving from decentralising to centralising distribution system as well as the benefits of this decision. There are different ways for centralising distribution system in which global companies adapt, such as direct system, multi-country warehouses, and Consolidation Centres. Both centralised and decentralised distribution systems will be highlighted to show how a company able to reap scale advantages more in a centralised than the decentralised one. ITT Flygt Company is utilized in as a case study to show the benefits in which this company achieves when it shifted from a decentralised to a centralised distribution system.

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Table of content 1

Introduction

Page 4

2

The concept of logistical system

Page 5

3

Centralized distribution

Page 6

4

Global distribution options

Page 9

4.1 physical distribution systems

Page 9

4.1.1 The direct system

Page 9

4.1.2 Classical system

Page 10

4.1.3 Transit system

Page 10

4.1.4 Multi-country warehouse

Page 10

4.2 Time-based and spatial consolidation

Page 10

4.2.1 Cross docking

Page 11

4.2.2 Merge-in-transit

Page 11

4.2.3 Manufacturing Consolidation Centre

Page 12

4.2.4 Mega Consolidation Centre

Page 12

4.2.5 Fresh Consolidation Centre

Page 13

5 Case study (ITT Flygt)

Page 14

6 Conclusion

Page 17

References

Page 18

Appendices

Page 20

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1 Introduction De Wit, and Meyer, (2005) argue that cross-border synergy is important aspect in achieving competitive advantage. One of the important activities for cross-border synergy is by to reap advantages by centralising activities, such as logistics, and production. Centralisation is achieved when those activities are physically combined together, which is called as sharing value-adding activities. The focus on this report is on centralisation of logistical activities, specifically distribution system, in global firms as a way to achieve economies of scale. The report will analyze the benefits of centralising distributions system in which companies achieve compared to the decentralized one, and different ways for centralizing logistics which companies are adopting. Lastly, ITT Flygt Company is utilized as a case study which identifies how it’s now able to reap scale advantages from shifting distribution system from decentralised to centralised one.

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2 The concept of logistical system Logistics has been identified by the Council of Supply Chain Management Professionals (CSCMP), (2005), p63, cited by Kohn, (2005), p.12 as: '' Logistics is that part of the supply chain process that plans, implements, and controls the efficient, effective forward and reverse the flow and storage of goods, services, and related to information between the points of origin and the point of consumption in order to meet customers' requirements.'' From this definition the main conclusion is logistics consists of a range of activities that need to be managed altogether to achieve customers' satisfaction and to meet organisational goals (Christopher, 1986, cited by Kohn, 2005). Logistics includes managing the flow of physical material , information management, in particular managing inventory, warehouses, distribution, different methods for products' distribution and transportation, logistical network design, and a third party logistics provider (CSCMP, 2005, cited by Kohn, 2005). According to Christopher, (1998), cited by Kohn, (2005), the logistics system consists of three elements: Procurement, operations, and distribution. The focus of this report will be on distribution.

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Centralized distribution

A distribution system includes a range of activities, such as moving goods or materials, warehousing, controlling inventory process, packaging, arranging locations, managing data collection, moving and handling materials, and network communication. It also includes moving goods from the manufacturer to the customer; and returning them to the manufacturer (CSCMP, 2005, P. 36, cited by Kohn, 2005). To achieve competitive advantage, many global firms are trying to be close to customers; however, this argument has two sided. On one hand, having warehouses in different locations enables firms to have a fast and reliable response to customers' demands. However, having a decentralised logistical system increases the cost of warehouses equipments, paying wages for employees, and increasing the total costs for the storage of goods in shelves for each warehouse (Coyle, Bardi, and Langley, 1988. cited by Kohn, 2005). According to Abrahamsson, (1992), cited by Kohn, (2005), because of advances in information technology it's now easy for firms to change the way of their distribution from a decentralised to a centralised system. This is a shift to Time Based Distribution (TBD), rather than a geographical system (figure 9). The theories behind this approach are theories of economies of scale and scope. Economies of scale describes the way of reducing cost by increasing scale (Pratten, 1975, cited by Kohn, 2005); whereas economies of scope identifies a new way for cost reduction by aggregating activities rather than separating them ( Panzer and Willig, 1981, cited by cited by Kohn, 2005).

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(Adapted from Kohn, 2005) Abbrahamsson, (1992); Abbrahamsson, and Brege, (1995) cited by Kohn, (2005) argue that to achieve economies of scale the distribution system has to be centralized in to the logistical structure, with the latter to include different activities, such as operations system, and logistics operations; and also should be treated as a separate function. Centralising distribution enables companies to sustaining price-based advantage by lowering the cost of operations. This is achieved by holding a higher volume of inventory than competitors. For example, Johnson, Scholes, and Whittington, (2008) argue that the latter can be achieved when a company centralises activities such as distribution to decrease total distribution channel costs, which is in line with theories of economies of scale.

Abrahamsson, (1992), cited by Kohn, (2005) finds two different advantages a firm can reap from having a centralised distribution system. • -

The logistical advantages:

Lowering the cost of warehouses. Running one warehouse

lowers the total cost of warehouses activities compared to having 7

more than one. Johnson, et al. (2008) argue this idea is inline with cost efficiency since running one big plant is cheaper than maintaining multiple warehouses, which leads to achieve economies of scale. -

Lowering the total cost, by lowering different costs by

decreasing the number of inventories as well as the cost of transportation remaining the same. -

Droge, and Germain, (1989) argue that other advantages include a

massive output of products/services being delivered due to having a centralised decision making system. •

Slack, Chambers, and Johnston, (2004), cited by Barnes (2008)

discuss operations performance criteria, including quality, reliable delivery, flexibility which includes fast delivery, and cost, which if a company could achieve, competitive advantage would be reaped. Those performance criteria are inline with other advantages, which are achieved by centralising distribution. these include: -

Lead-time will be shorter and safer for all products at any location.

-

Better delivery services, as this leads to achieving efficiency through

more reliable deliveries. -

Fast and flexible response to customers' demand.

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Although products will be shipped over a long distance to reach

customers because they need to be transferred from the central warehouse, the total cost of the transportation won’t be very high, and that’s because there’s no need for urgent transport. For example, in the decentralised warehouses, if some stocks were to run out, there would be need for emergency transportation from the manufacturer. To achieve the latter, an urgent transportation would be required to deliver the required product. These might require either air transportation; or via fast delivery, which are both costly (Kohn, 2005).

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4

Global distribution options

Becker, Verdujin, and Kuipers, (2003) divide the distribution options into the following two categories: 4.1 physical distribution systems: Picard, (1982) cited by Becker et al, (2003) argue that any global companies have to make a number of decisions before adapting an appropriate network. Those decisions include the physical distribution systems. Both centralised and decentralised distribution systems will be discussed to show how they achieve economies of scale. 4.1.1 The direct system: in this option products are sent directly from the manufacturer to the final customer. This is costly, as it requires fast and reliable deliveries (figure 4). In addition, products’ final touches, such as labelling, packaging and quality checks are made at the manufacturer. Li, (2008) argues the most important advantage from this system is all inventories are centralised at the manufacturer, Dell adapts this system.

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Figure 4: Manufacturer storage with direct shipping (Chopra, and Meindl, (2007) adapted from Li, (2008).

In addition, Chopra, (2003) argues it enables the manufacturer to benefits from low inventories even more by postponing products until the order arrives. The manufacturer is then able to change and modify products to meet customers’ requirements (Van Hoek, 1998), which leads to inventory reduction. Furthermore, this approach enables all supply chain to save the cost of warehouses as all inventories are kept at the manufacturer. However, drop shipping, as this system is called by Chopra, (2003), has drawbacks, as it's dependant on a good information system that links the retailer with manufacturer to place orders. In addition, it takes a long time to deliver products from manufacturer to customers. Furthermore, it has a high transportation cost, as products travel through a long distance to reach their final destiny. 4.1.2 Classical system: Becker, et al, (2003) argue in this system the manufacturer is on one continent, and the warehouses are in another continent close to customers. Both are related by ports. In case of ocean shipments, they are mainly preferred because they are cheaper than air cargo. In addition, this option allows exploitation of economies of scale, as it allows to aggregating shipments. 4.1.3 Transit system: this system is similar to the one above, as the manufacturer is placed in one continent and connected by satellite warehouses, which are located in another continent to be close to the market, and both are linked by ports (Becker, et al,

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2003). The biggest advantage of this option is that inventory level is kept to minimum by keeping stocks at the manufacturer. However, the cost of transportation is high because aggregating shipments are less likely to occur and when demand for products is increased, responding to demands by satellite warehouse won’t be easier. Manufacturer spare parts are utilising this option. 4.1.4 Multi-country warehouse: Some global companies have a central warehouse serves all countries. Products are distributed to the central warehouse via sea. The transportation in this option is slow and aggregated, then they will be transferred either direct to the customer, or to other midpoints. The former is used as a transit system, or as a stock location, as in the classical system. 4.2 Time-based and spatial consolidation: According to Becker et al, (2003), this strategy consolidates achieving economies of scale and time reduction, by cooperation between manufacturers, with both logistical activities providers and retailers. This concept includes the following options: 4.2.3 Manufacturing Consolidation Centre: this centre is based on a combination of manufacturers that require similar logistical activities (ATO-DLO, 2001, cited by Becker et al, 2003). Products are distributed in one delivery which enables companies to deliver in a regular manner one full truck shipment to the distribution centres. Those products then are distributed differently according to the retailers’ plans. A manufacturer in this option is looking for a partner who shares similar customers, or a partner who has similar logistical barriers, to reap synergy returns. Frozen food manufacturers are adapting this option. 4.2.4 Mega Consolidation Centre refers to a centre where the manufacturer and retailer aggregate products’ transportation and warehouses that requires similar logistical system (ATO-DLO, 2001, cited by Becker et al. 2003). Those centres expanded Manufacturing Consolidation Centre duties by including the retailers’ distribution centres. Frozen food, for example, is processed via this way.

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4.2.5 Fresh Consolidation Centre (FCC): This centre combines fresh merchandise and is located close to retailers. It aggregates those products according to retailers’ requirements. ATO-DLO, (2001) cited by Becker et al. (2003) argue these centres aim at fast and reliable deliveries. Farming products utilize this option. Transportation in this option is made direct from the manufacturer to the FCC. In addition, this option requires regular deliveries. From those options it can be concluded that centralised systems allow exploitation of economies of scale by reducing transportation costs more than can be achieved in decentralised systems.

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Case study (ITT Flygt) This case study adopted from Kohn, (2005). For more detail, see appendix 3. ITT Flygt is a glass mould manufacturer in Sweden, which has now become a successful global company producing pumps. Until 1999, the ITT Flygt distribution system was decentralised, as holding a huge number of stocks at each local store around the world. The reason was because before the development of European Union, it was difficult to transfer products across the world, while sharing one pumps supplier, Lindas. The latter sent products to each country according to their requirements. The problem was the long time takes between placing the order and delivery time. In addition, express deliveries were another problem for some countries, UK for example. This option was used to ship goods to customers in emergency time, and also it was used by Lindas to deliver products to the UK. From the UK perspective, this transport was slow and didn’t meet customers’ requirements. Therefore, it was hard for the company to standardise products as each local company worked autonomously. In addition, 12

local inventory costs were high because of the time between placing an order and receiving it. Furthermore, because each local company acted separately, there were a huge number of carriers engaged to deliver. As a result, ITT Flygt realised the importance of changing its distribution system to a centralised system, which provides a standard products across the world. The final decision was to replace eight warehouses with a central one, which aims at holding a wide variety of products and stocking them in case of increase demand. Metz, in France was the location where the company decided to have its central warehouse (Figure 7).

Figure 7: Depiction of generic distribution flows in ITT Flygt’s centralised distribution system (adapted from Kohn, 2005). Another feature ITT Flygt had to look at was deceasing the number of carriers to only two, namely DHL and Wincanton, which will have an impact on cost reduction. Metz attached a new system, SDC Metz, to ensure that time and type of order for each company is appended to this system. SDC Metz on a daily bases has lorries ship goods to Wincanton then from there to different parts of the world. Packaging and loading were another area ITT Flygt has to look at to ensure that they are operated and shipped effectively to develop the fill-rate between Lindas and Metz.

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As a result, the flow of goods between Lindas and Metz was improved between 2003 and 2004 (appendix 1). Implementing a centralised system has allowed ITT Flygt to reap scale advantages, by reducing cost relating to logistics. This includes transportation costs for many reasons. For example, the ability to negotiate for the best transport price for those services is decided centrally. In addition, the total cost of express and emergency deliveries decreased. Furthermore, this system enables SDC Metz to raise its service level in 2003 to 95% (appendix 2).

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Conclusion Centralising logistics is becoming a predominant trend amongst global companies for many reasons. The most important reason is achieving economies of scale. This is achieved by lowering the cost of warehouses, as running one warehouse leads to lowering the total cost of warehouse activities compared to having multiple warehouses. In addition, having a central warehouse leads to a decrease in the number of inventories and the cost of transportation is fixed. Logistical activities consist of procurement, operations, and distribution. However, the focus on this report was of centralising distribution as a way to reap scale advantages. There are different ways for centralising distribution, such as direct system, multicountry warehouse, and Consolidation Centres. Although those systems have disadvantages, they proved to reap economies of scale advantages to a great extent than in decentralised systems. ITT Flygt was an example of a decentralised system, which led to major consequences, such as making it was difficult to standardise products as each local company worked autonomously. In addition, local inventory costs were high because of the time taken between placing an order and receiving it. Furthermore, because each local company acted separately, there were a huge number of carriers engaged to deliver. However, implanting a

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centralised system has allowed ITT Flygt to reap scale advantages, by reducing cost relating to logistics including transportation cost (Kohn, 2005).

References -

Barnes, D. Operations Management. London: Thomson Learning,

(2008). -

Becker, J.F.F, Verduijn, T.M., and Kuipers, B. (2003). Innovative

global logistics concepts. Consolidation centres and goods flows of global players. No. 03 3N 017 32091. Netherland Organisation. TNO.

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Chopra, S. Designing the distribution network in a supply chain.

Transportation Research Part E 39, 2003: 123-140. -

Coulter, M. Strategic Management in Action. Upper Saddle River:

Pearson Education, (2008). -

De Wit, B. and Meyer, R. Strategy Synthesis. Resolving Strategy

Paradoxes to Create Competitive Advantage. London: South-Western, 2005.

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-

Droge, C. and Germain, R. The Impact of the Centralized Structuring

of Logistical Activities on Span of Control, Formalization and Performance. Journal of the Academy of Marketing Science. Vol.17, No 1, 1989: Page 83-89.

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Johnson, G., Scholes, K. and Whittington, R. Exploring Corporate

Strategy. Harlow: Pearson Education, 2008.

- Kohn, C., (2005). Centralization of Distribution Systems and its Environmental Effects. . Ph.D. International Graduate School of Management and Industrial Engineering: IMIE. -

Li, C., (2008). Framework for Selection of Distribution Strategies.

Master Dissertation. Massachusetts Institute of Technology.

-

Van Hoek, R. Reconfiguring Logistics systems through postponement

strategies. Journal of Business Logistics. Vol. 19, No.1, 1998: Page 33-53.

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Appendices

Appendix 1: Fill-rate comparison between 2003 and 2004 for transfers between Lindas and sales companies/final customer. Adapted from adapted from Kohn, (2005). 17

Appendix 2: Monthly delivery performance for SDC Metz 2003 (adapted from Kohn, 2005).

Appendix 3: ITT Flygt (adapted from Kohn, 2005) 3.1.1.Company history

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Sweden is well known for its many glassworks and Peter Alfred Stenberg specialised in producing and equipment for the many surrounding companies. Just over a decade ironmoulds later the was restructured and given the new name Lind‫ه‬s Gjuteri & Formfabriks AB company (Lind‫ه‬s Foundry & Mould Factory) and a few years later Peter Alfred Stenberg transferred the responsibility for the factory to his children. Later on, in 1929, an engineer from Stockholm named Hilding Flygt advertised in the daily newspaper in order to find a company that was able to manufacture the products his

company developed, namely pumps. The Stenberg brothers responded to the advert and the cooperation between Hilding Flygt and the Stenbergs in Lind‫ه‬s saw the light. About a year later the company was able to introduce its first pump, the “universal pump” (see Figure 20).

Figure 20: The company's first pump, the "universal pump" Almost two decades later, in 1947, Hilding Flygt decided to retire and AB Flygts Pumpar wasStenberg brothers in Lind‫ه‬s. In the same year the company introduced the sold to the world’s first submersible pump thanks to the engineering knowledge of Sixten Englesson, an employee of Over the subsequent years the company introduced new pumps, the company. started an and export company, established foreign subsidiaries. In 1968 the American multinational

company International Telephone & Telegraph Corporation, better known as ITT, acquired the company through an exchange of shares, and the following decade the Lind‫ه‬s plant grew tremendously as an expanding range of products were introduced. Later on, in 1991, the company name was changed to ITT Flygt AB, a name that the company holds to this day. Today ITT Flygt is the world’s largest manufacturer of submersible pumps and mixers, and is renowned for producing efficient and versatile products of the highest quality. ITT Flygt’s vision is to be recognised as the leading supplier of solutions and services in fluid handling with

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submersible products worldwide. In trying to live up to this reputation as a market innovator has the recently released the N-pump, which promises to revolutionise company

submersible pumping, much in the same manner as the first submersible pump did just over half a century ago.

3.1.2 Facts and figures With its 44 wholly or partly owned sales offices, representation in over 130 countries around the world, production plants in Sweden, Germany, the Netherlands, Argentina, and China, and distribution centres in Sweden and France, ITT Flygt can truly be considered an international company. The company has over 4,000 employees, of which over 2,500 are stationed outside Sweden.ofThe corporate headquarter is located in Stockholm, as well as the departments of Research & Development, Marketing, Flygt International, and the Swedish sales

company. The largest production plant is located in Lind‫ه‬s, where the company has its roots, and in 2003 approximately 78,000 out of the company’s total production of 130,000 pumps were manufactured here, as well as 8,500 out of 8,600 mixers. The departments of Finance, Quality, and Shipping are also located in Lind‫ه‬s; whereas Purchasing, Human Resources, and IT/IS are that are divided between Lind‫ه‬s and Stockholm. Figure 21 below shows an functions organisational chart of the ITT Flygt Group. ITT Flygt Group CEO

Product Management

Research & Development

Operations

Manufacturing & Distribution

Product Management

Finance

BU – Public Utiliy

Information Technology, Bus. Proc. Development, Quality & ESH Human Resources & Corporate Communication

Technical Support

Lind‫ه‬s Plant

BU – Construction & Mining Market Communication

Research & Development – other units

Flygt Werk

BU – Industry

SDC Metz

Region Europe

Group Purchasing, Logistics & Production Engineering

Region Americas

Manufacturing

Region Asia Pacific

Value Based Six Sigma

Business Development

Figure 21: Organisational chart of the ITT Flygt Group

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Today, ITT Flygt is the flagship of the ITT Fluid Technology division, which is a business segment of ITT Industries where all companies in the group are active in developing fluid systems and solutions in order to move and control water and other fluids. Fluid

Technology is one of four business areas, where the other three areas include Electronic Components, Defense and Motion & Flow Control, and represents 40 % of total sales Electronics & Services, for ITT Industries. The corporate headquarter of ITT Industries is located in White Plains, New York and the company employs about 38,000 people all over the world. It is noted on the New StockYork Exchange as well as on the stock exchanges US Midwest, US Pacific, London, Paris, and Frankfurt.

3.1.3 The market In 2003 ITT Flygt had a turnover of approximately US$ 763 million, where the European and US markets make up for almost 90 % of total revenues (see Figure 22). Just over 50 % of these sales can be attributed to the waste-water segment, with industry and construction making up other large segments, and 20 % and 18 % of sales come from these respective segments.

2%

9% 3%

Africa and the Middle East Asia and the Pacific Ocean

58%

28%

South America North America Europe

Figure 22: Sales per region for ITT Flygt ITT Flygt is considered to be a premium brand on the submersible pump market and the pumps are used in various settings and environments. For instance they are used to pump waste-water in the London Docklands, to drain mines in South Africa from water, or to create manmade surfing waves in Texas. Just as with most other industries ITT Flygt has a number of

companies with whom it needs to compete over market shares and currently some of the larger competitors include Grundfos and ABS Pumps. Earlier ITT Flygt considered the market in a somewhat narrow manner, or rather the market was defined as just selling pumps, and with this view the company considered itself to have a market share of approximately 25 %. Today, the company defines the market in a broader fashion and

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the goal is not only to supply a submersible pump, but instead to supply a complete system installation and other services. When the market is defined by using these including

criteria, ITT Flygtthen instead considers its market share to be approximately 5-10 %. However, the company has presented an offensive strategy for the coming years, a strategy where the company shall grow substantially over the coming years and increase its overall market share. This expansion shall be achieved through extensive acquisitions as well as increases in sales on markets outside of Europe and the U.S.

3.1.4 The pump Even though many of the pumps ITT Flygt in fact sell look and operate in a similar fashion, companythe does not have a standard or pre-specified product that the customer can

pick out from a catalogue in the same manner as they could do if they bought something from Elfa or IKEA. This is because a product can come in more or less a million different configurations, since cables, voltage for motors, or material for the sealing jointing and the like can vary depending on of the customer in question. Figure 23 below illustrates typical the preference products of ITT Flygt.

Figure 23: Typical ITT Flygt pumps Until the 1960s ITT Flygt was a rather small company and it was not that difficult to specify what each of the products were to have as they were ordered, since volumes components were large not andthat therefore the workload was manageable. Sales representatives went out into the field and sold pumps to the customers through the use of brochures, technical

specifications, curves etceteraeffect and could quite easily specify the characteristics that described a certain product. These were then transferred to the factory where personnel translated these orders

into specific articles so that the customers received the pump they actually requested. These lists could contain, depending on the type of pump, between 50 and 100 articles.

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When ITT Flygt started expanding on new markets and the volumes started to grow, this way was of no longer feasible since this would be too time consuming. Therefore, the working company in the 1970s introduced an identity system, a system that had the purpose of making it possible identify all to objects, e.g. single parts, components, or a complete unique product. This system be seencan described as an “identity pyramid” and Figure 24 below gives an example of what this look like. may

CP 3085

Sales denomination

3085.182

Product code

308 5.182-010 308 5.182-0025 3085.182-010-1 51-232-300414-599-699-700-80 5-999 3085.182-9511235 82 40 59, 397 75 00

Module Product number Delivery code (module combination) Serial number Parts

Figure 24: Example of the ITT Flygt "Identity pyramid" When a customer today sees a pump, the sales representative sees a product code according torules that the company have decided upon in the technical administration the identity system. The order is then handled by the order personnel, who for that particular product group match customer requirements with the matching articles in each of the module groups, e.g. motor module group, cable group, or pump wheel group. The final product then is actually a configuration of various modules. This way of describing the products has turned out to beefficient a very way of describing all the parts, components, and modules, and it has become clear and easy to see all available product combinations.

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