Network Design

in the Supply Chain

 Network Design Decisions
• Facility role: What role should each facility play? What
processes should be performed at each facility?

• Facility location: Where should facilities be located?

• Capacity allocation: How much capacity should be allocated to

each facility?

• Market and supply allocation: What markets should each

facility serve? Which supply sources should feed each facility?

• (How many plants, DC’s, retail stores, etc. to build?)

 Phase I: Strategy Considerations
• Understand where is the main emphasis:
– Cost leadership
– Responsiveness
– Product differentiation
• Who are the key competitors at each target market?
• Identify constraints on available capital
• Key mechanisms that will support growth
– Reuse of existing facilities
– Build new facilities
– Partner with other companies (mergers and acquisitions are potential
options here)
 Cost / Responsiveness Trade-off
Cost
Total cost
SC response time

Inventory cost

Facility cost

Transportation cost

Number of Facilities
 Phase II: Regional facility
configuration
• Important Factors:
• Regional demand
• Production technologies and economies of scale
and scope
• Tariffs and Tax incentives
• Infrastructure factors
• Political, exchange rate and demand risk
• Competitive Environment
 Regional demand

• Forecast the demand on a region by region basis

• Need to study its
– size
– homogeneity
• Non-homogeneous demand will require a more localized
network
• Frequently the final customization of a product for a particular
market is done at a local distribution center
– Labeling
– Manuals
– etc.
 Production technologies and the
underlying economies
• Expensive dedicated production technologies will require large
production volumes and therefore a more centralized production
network (e.g., chip production).
• Lower fixed cost facilities can be duplicated more easily (e.g.,
bottling factories).
• In case of non-homogeneous demand, technological flexibility
facilitates consolidation of production to a few manufacturing
facilities.
• The more cumbersome the transfer of raw material, the closer the
facility must be to the source site (e.g., factories processing
minerals)
 Tariffs and Tax incentives
• Tariffs: Any duties that must be paid when products and/or equipment are
moved across international, state or city boundaries.
• High tariffs necessitate localized production.
• Presently, there is a systematic effort to open the markets to global competition
through the World Trade Organization Policies (WTO) and regional
agreements (NAFTA, MERCOSUR for S. America, ASEAN for Pacific rim,
etc.)
• Tax incentives: a reduction in tariffs or taxes that countries, states and cities
often provide to encourage firms to locate their facilities in specific areas.
• Free trade zones: Areas where duties and tariffs are relaxed as long as
production is used primarily for export (e.g., Taiwan and China’s GuangZhou
area) Allows companies to take better advantage of low labor costs.
• Tax incentives can be focusing on certain
– Industries
– Technologies
– Regions
• Quotas: Limits on import volumes placed by different countries in an effort to
protect their local industry. Sometimes there is also some requirement on
minimum local content.
 Infrastructure factors
• Availability of skilled labor
• Availability of transportation facilities
– Ports
– Airports
– Rail
– Highways
• Availability of necessary utilities
– Power
– Water
– Sewage
– Telecommunications / IT
 Political, exchange rate and demand
Risks
• Political risks -- Need for:
– Well-defined rules of commerce
– Independent and clear legal systems
– Political stability
• Exchange rate risks: This risk arises from the fact that companies might incur
their costs in one currency and collect their revenues in other currencies. (e.g.,
Japanese production under an expensive Yen in the late 80’s / early 90’s; the
role of an expensive EURO these days for the American economy)
• Potential protection to exchange rate risk: Build some flexible over-capacity
to the regional facilities so that production is shifted to the lower-cost regions.
• Demand risk: Comes from extensive demand fluctuation due to regional
economic crises (e.g., Asia markets between 1996-1998) Plant flexibility is
also a potential protection to this type of risk.
 Competitive factors
• Positive Externalities: Instances where collocation of multiple firms benefits all
of them, since
– They share the cost of the necessary infrastructure
– And the collocation can stimulate demand for all of them
– Examples: a mall, silicon valley, industrial parks
• Locating to “split the market”: For companies that
– Do not have price control, and
– try to maximize their market share by minimizing their distance from the customer,
collocation can allow each competing party to maximize their market share.

a b

Total demand = 1

D1 = a + (1-b-a)/2 = (1+a-b)/2 a = b = 1/2

D2 = 1-a-(1-b-a)/2 = (1+b-a)/2
=>
 A (production) facility categorization
(Kasra Ferdows, 1997)

• Offshore Facility: Low-cost facility for export production

• Source Facility: Low cost facility for global production – facilities with more
strategic role in the SC, resulting from the evolution of good offshore
facilities

• Server Facility: Regional production facility

• Contributor Facility: Regional production facility with development skills

(mainly focusing on customization for the local market)

• Outpost Facility: Regional production facility built to gain local skills

• Lead Facility: Facility that leads in development and process technologies

 Phases III & IV: Selecting specific
locations
• Important factors
• Infrastructure
• Costs
– Labor
– Materials
– Facilities
– Transport
– Inventory
– Taxes and Tariffs
 Integrated SCM
• Implementing integrated SCM requires:
– Analyzing the whole supply chain
– Starting by integrating internal functions first
– Integrating external suppliers through partnerships
• Manufacturer’s Goals  Supplier’s Goals
– Reduce costs  Increase sales volume
– Reduce duplication of effort  Increase customer loyalty
– Improve quality  Reduce cost
– Reduce lead time  Improve demand data
– Implement cost reduction program  Improve profitability
– Involve suppliers early
– Reduce time to market
© 2010 Wiley 14
 Supply Chain Measurements
• Measuring supply chain performance
– Traditional measures include;
• Return on investment
• Profitability
• Market share
• Revenue growth
– Additional measures
• Customer service levels
• Inventory turns
• Weeks of supply
• Inventory obsolescence
© 2010 Wiley 15
 Supply Chain Performance
Measurement
• Customer demands for better-quality requires
company’s to develop ways to measure
improvements
• Some measurements include
– Warranty costs
– Products returned
– Cost reductions allowed because of product defects
– Company response times
– Transaction costs
© 2010 Wiley 16
 Eliminating Sources of Waste in
Supply Chain
• Overproduction: don’t build product before
needed
• Delay between activities in chain: eliminate
them
• Unnecessary transport or conveyance of
product: includes both internal and external
movement

© 2010 Wiley 17
 Eliminating Sources of Waste in
Supply Chain con’t
• Unnecessary movement of people: includes travel
or reaching due to poorly designed work space
• Excess inventory ready and in position: includes
early deliveries, excess inventory, etc.
• Suboptimal use of space: trailer loads,
warehouses, etc.
• Errors that cause rework: billing errors, inventory
discrepancies, etc.

© 2010 Wiley 18
 Current Trends in SCM
• Increased use of electronic marketplace such as
– E-distributors – independently owned net
marketplaces having catalogs representing thousands
of suppliers and designed for spot purchases
– E-purchasing – companies that connect on-line MRO
(maintenance, repair, operations) suppliers to business
who pay fees to join the market, usually for long-term
contractual purchasing

© 2010 Wiley 19
 Current Trends in SCM -
continued
• Increased use of electronic marketplace such as
– Value chain management – automation of a firm’s purchasing
or selling processes
– Exchanges – marketplace that focuses on spot requirements of
large firms in a single industry
– Industry consortia – industry-owned markets that enable buyers
to purchase direct inputs from a limited set of invited suppliers
• Decreased supply chain velocity due to greater distances
with greater uncertainty and generally less efficient.

© 2010 Wiley 20
 SCM Across the Organization
• SCM changes the way companies do business.
• Accounting shares SCM benefits due to inventory level
decreases
• Marketing benefits by improved customer service levels
• Information systems are critical for information sharing
through PSO data, EDI, RFID, the Internet, intranet, and
extranets
• Purchasing is responsible for sourcing materials
• Operations use timely demand information to more
effectively plan production schedules

© 2010 Wiley 21
 Network Design Decisions
• Facility role
• Facility location
• Capacity allocation
• Market and supply allocation

5-22
 Factors Influencing
Network Design Decisions
• Strategic
• Technological
• Macroeconomic
• Political
• Infrastructure
• Competitive
• Logistics and facility costs

5-23
 The Cost-Response Time
Frontier
Hi Local FG
Mix
Regional FG

Local WIP
Cost Central FG

Central WIP

Central Raw Material and Custom production

Custom production with raw material at suppliers

Low
Low Response Time Hi

5-24
 Service and Number of Facilities
Response
Time

Number of Facilities

5-25
Where inventory needs to be for a one week order response time -
typical results --> 1 DC

Customer
DC
Where inventory needs to be for a 5 day order response time -
typical results --> 2 DCs

Customer
DC
Where inventory needs to be for a 3 day order response time -
typical results --> 5 DCs

Customer
DC
Where inventory needs to be for a same day / next day order
response time - typical results --> 26 DCs

Customer
DC
Costs and Number of Facilities
Inventory

Facility costs
Costs

Transportation

Number of facilities

5-30
 Cost Buildup as a Function of Facilities
Total Costs
Cost of Operations

Percent Service
Level Within
Promised Time

Facilities
Inventory
Transporta
Labor
tion

Number of Facilities

5-31
 A Framework for
Competitive STRATEGY
Global Site Location
PHASE I
GLOBAL COMPETITION

Supply Chain
INTERNAL CONSTRAINTS Strategy
Capital, growth strategy, TARIFFS AND TAX
existing network INCENTIVES

PRODUCTION TECHNOLOGIES REGIONAL DEMAND

Cost, Scale/Scope impact, support PHASE II Size, growth, homogeneity,
required, flexibility
Regional Facility local specifications
Configuration
COMPETITIVE
ENVIRONMENT POLITICAL, EXCHANGE
RATE AND DEMAND RISK

PHASE III
Desirable Sites AVAILABLE
INFRASTRUCTURE
PRODUCTION METHODS
Skill needs, response time

FACTOR COSTS PHASE IV LOGISTICS COSTS

Labor, materials, site specific Location Choices Transport, inventory, coordination

5-32
 Conventional Network
Materials Customer
Vendor Finished Customer
DC Store
DC Goods DC DC
Customer
Componen Store
Vendor t
DC Plant Customer Customer
Manufactu
Warehouse DC Store
ring
Components
DC Customer
Vendor
Finished Store
DC Customer
Final Goods DC DC Customer
Assembl Store
y 5-33
 Tailored Network: Multi-Echelon
Finished Goods Network

Local DC
Store 1
Regional Cross-Dock
Customer 1
Finished DC Store 1
Goods DC Local DC
National Cross-Dock Store 2
Customer 2
Finished
DC
Goods DC Local DC Store 2
Regional Cross-Dock
Finished Store 3
Goods DC
Store 3

5-34
 Gravity Methods for Location
• Ton Mile-Center Solution
– x,y: Warehouse Coordinates
– xn, yn : Coordinates of delivery ( x  xn)  ( y  y n)

2 2
d n
location n
x
 Dn F d
k
n n

– dn : Distance to delivery x n 1 n

F
 Dn d
k

location n n 1
n

– Fn : Annual tonnage to delivery y

 Dn F d
k
n n

y n 1 n
location n F
 Dn d
k
n

n 1 n

Min  d n Dn F n
5-35
 Network Optimization Models
• Allocating demand to production facilities
• Locating facilities and allocating capacity
Key Costs:

• Fixed facility cost

• Transportation cost
• Production cost
• Inventory cost
• Coordination cost

Which plants to establish? How to configure the network?

5-36
 Demand Allocation Model
• Which market is served n m

by which plant? Min  cij xij

i 1 j 1

• Which supply sources s.t.

are used by a plant? n

 x  D , j  1,..., m
i 1
ij j
xij = Quantity shipped from m

plant site i to customer j  x  K , i  1,..., n

j 1
ij i

x ij
0

5-37
 Plant Location with Multiple
Sourcing
• yi = 1 if plant is located
at site i, 0 otherwise
• xij = Quantity shipped n n m
Min  f y   cij xij
from plant site i to s.t.
i 1
i i
i 1 j 1

customer j n

 x  D , j  1,..., m
ij j
i 1
n

 x  K y , i  1,..., n
j 1
ij i i

 y  k ; y {0,1}
i 1
i i

5-38
Plant Location with Single Sourcing
• yi = 1 if plant is located n n m
Min  f y   D j c x
at site i, 0 otherwise i 1
i i
i 1 j 1
ij ij

• xij = 1 if market j is s.t.

supplied by factory i, 0 n

otherwise
x
i 1
ij
 1, j  1,..., m
n

 D j x  K y , i  1,..., n
j 1
ij i i

xij , y {0,1}i

5-39
Summary of Learning Objectives
• What is the role of network design decisions in
the supply chain?
• What are the factors influencing supply chain
network design decisions?
• Describe a strategic framework for facility
location.
• How are the following optimization methods used
for facility location and capacity allocation
decisions?
– Gravity methods for location
– Network optimization models

5-40