CHAPTER 12: Network Design

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Network design overview

Enterprise facility network Warehouse requirements Systems concept and analysis Total cost integration Formulating logistical strategy

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Enterprise facility network

Availability of economical transportation provides opportunity for facility networks Design requirements are from integrated procurement, manufacturing and customer accommodation strategies
Logistics requirements are satisfied by achieving total cost and service trade-offs

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Spectrum of location decisions exists but chapter focus is on selecting warehouse locations
Transportation services link locations into an integrated logistical system Selection of individual locations represents competitive and cost-related logistical decisions
Manufacturing plant locations may require several years to fully deploy Warehouses can be arranged to use only during specified times Retail locations are influenced by marketing and competitive conditions
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Local presence: an obsolete paradigm

Local presence paradigm Transportation services started out erratic with few choices Customers felt that inventory within the local market area was needed to provide consistent delivery Contemporary view Transportation services have expanded Shipment arrival times are dependable and consistent Information technology
Provides faster access to customer requirements Enables tracking of transport vehicles

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Warehouse requirements
Warehouses exist to lower total cost or improve customer service Warehouses specialize in supply or demand facing services
Facilities used for inbound materials are supply facing warehouses Facilities used for customer accommodation are demand facing warehouses

Functionality and justification are different based on facilities support role

Procurement Manufacturing Customer accommodation
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Procurement drivers help purchase materials and components at the lowest total inbound cost
Limited number of deeper relationships with suppliers Life cycle considerations
E.g. material purchase, reclamation, and disposal of unused materials

Debundling of value-added services leading to new structural relationships with suppliers Seasonality of selected supplies Opportunities to purchase at reduced prices Rapid accommodation of manufacturing spikes Facilities placing more emphasis on sorting and sequencing materials

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Manufacturing drivers help consolidate finished product for outbound customer shipment
Provide customers full-line product assortment on a single invoice at truckload transportation rates Choice of manufacturing strategy is primary driver
Make to plan (MTP)
Requires substantial demand facing warehousing

Make to order (MTO)

Requires supply facing support, but little demand warehousing

Assemble to order (ATO)

Requires some demand warehousing as product and components may be assembled to a degree using postponement principle

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Customer accommodation drivers provide custom inventory assortments to wholesalers/retailers

Maximize consolidation and length of haul from plants Rapid replenishment from wholesalers
E.g. food and mass merchandise industries

Market-based ATO situations using decentralized warehouses Size of market served by warehouse based on
Number of suppliers Desired service speed Size of average order Cost per unit of local delivery

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Warehouse justification is based on providing a service or cost advantage from their location
Must achieve freight consolidation with warehouse positioning
Inventory storage to support customized orders Mixing facilities to support flow-through and crossdock sorting

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Key design questions to ask when developing a logistics network

How many and what kinds of warehouses should a firm establish? Where should they be located? What services should they provide? What inventories should they stock? Which customers should they service?

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The Systems Concept

Systems concept is an analytical framework that seeks total integration of components essential to achieving stated objectives Components of logistical system are its functions
Order processing Inventory Transportation Warehousing Materials handling and packaging Facility network design
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Systems analysis seeks to quantify trade-offs between logistics functions

Goal of system analysis is to create an integrated effort (i.e. a whole) which is greater than its individual parts Goal from a process perspective is balanced performance between functional areas both within the enterprise and across its supply chain Functional excellence is the contribution a function makes to the success of the overall system (or process) Focus of system analysis is on interactions (i.e. relationships) between components

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Principles of general systems theory

Total system performance is singularly important Individual components dont need to be optimized
Emphasis is on the integrated relationship between components

A functional relationship exists between components called a trade-off

May enhance or hinder total system performance

Components linked together in a balanced system will produce greater end results than possible through individual performance

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A systems concept example

Customer service is an integral part of total system performance However,
Customer service must also be balanced against other components Accommodating the customer to the extent that you put yourself out of business is not serving the customer! There must be a balance between cost and customer service Building relationships with customers is key to this balance
i.e. customers become a component of the supply chain system

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Total cost integration

Initial network of facilities are driven by economic factors
Transportation economics Inventory economics

Cost trade-offs of these individual functions are identified, but

A system analysis approach (i.e. total cost integration) is used to identify the least-total-cost for the combined facility network

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Transportation economics
Two basic principles for economical transportation
Quantity principle is that individual shipments should be as large as the carrier can legally transport in vehicle Tapering principle is that large shipments should be transported distances as long as possible

Cost-based warehouse justification Network transportation cost minimization

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Example of cost-based warehouse justification using transportation consolidation

Assumptions
Average shipment = 500 lbs Freight rate to customer = $7.28 per cwt Volume transport rate = $2.40 per cwt
For shipments 20,000+ lbs

Options
Direct ship to customer = $36.40 per average shipment Ship to market at volume rate and distribute locally
Total rate = $3.75 per cwt $18.75 per average shipment

Local delivery within market = $1.35 per cwt

Can you justify the use of a warehouse in this situation?

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Transportation cost Integration (Spatial)

Basic economies
Economy of size (quantity discount) Economy of distance (tapering principle)

Activity based cost

Loading and unloading Movement Information

Generalized relationship
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Transport cost as a function of distribution locations

Total Transport Transport Cost

Inbound

Outbound Number of Distribution Locations

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Network transportation cost minimization

Figure 12.2 Transportation Cost as a Function of the Number of Warehouse Locations

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Inventory economics is driven by service response time

Performance cycle is key driver Forward deployment of inventory potentially improves service response time, but
Increases overall system inventory

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Service-based warehouse justification

Inventory consists of
Base stock Safety stock In-transit stock

What is the impact of adding warehouses to each of these inventories?

Base stock is independent of number of market facing warehouses What about in-transit stock?

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Additional warehouses typically reduce total in-transit inventory

Figure 12.3 Logistical Network: Two Markets, One Warehouse

Figure 12.4 Logistical Network: Two Markets, Two Warehouses

Table 12.1 Transit Inventory under Different Logistical Networks

Results

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What about the impact on safety stock?

Safety stock is needed to protect against unplanned stockouts during inventory replenishment Uncertainty in network is impacted by adding warehouses
Performance cycle days are reduced Number of performance cycles increases
Prevents aggregation of uncertainty across market areas

Serving the same market area by adding warehouses will increase uncertainty since each facility has its own replenishment cycle
Therefore, more safety stock is needed
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Combining demand into one warehouse averages demand variability

Table 12.4 Summary of Sales in One Combined and Three Separate Markets

More safety stock is required if markets served from local warehouse

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Inventory summary
Base stock determination is independent of number of market facing warehouses In-transit stock will typically decrease with the addition of warehouses to the network Safety stock increases with number of warehouses added to the network
New performance cycle requires additional safety stock

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Network inventory cost minimization

Figure 12.5 Average Inventory as a Function of Number of Warehouse Locations

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Total cost of the network is illustrated in Figure 12.6

Figure 12.6 combines cost curves from Figure 12.2 and 12.5 Lowest cost points on each curve
For total transportation cost between 7 and 8 facilities For inventory cost it would be a single warehouse For total cost of network it is 6 locations

Trade-off relationships
Minimal total cost point for the system is not at the point of least cost for either transportation or inventory
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Illustration of total cost concept for the overall logistical system

Figure 12.6 Least-Total-Cost Network

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Minimize the cost of your logistics network without compromising your service levels
$90 $80

Cost (millions $)

$70 $60 $50 $40 $30 $20 $10 $-

Optimal Number of Warehouses

Total Cost Transportation Cost Fixed Cost Inventory Cost

10

Number of Warehouses
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LogicNet Case Study: Current Network for MetalWorks

Plants
Dover Des Moines

DCs
Dover Des Moines

Customers are sized by demand

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LogicNet Case Study: Current Network for MetalWorks

Total Cost: $69,500,000 Average Distance to Customers: 750 Miles

Plants
Dover Des Moines

DCs
Dover Des Moines

Indicators show utilization of DCs

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Assumptions are important to understand for their impact on finalizing a strategy

Analysis summarized in Figure 12.6 does not include all relevant costs
Projected sales based on a single planning period Transportation costs based on a single average-size shipment Desired inventory availability and fill rate assumptions impact the solution

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Limitations to accurate total cost analysis

Many important costs are not specifically measured or reported Need to consider a wide variety of network design alternatives
Alternative shipment sizes Alternative modes of shipment Range of available warehouse locations
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Formulating logistical strategy requires evaluating alternative customer service levels and costs General approach to finalizing a logistical strategy
Determine a least-total-cost network
Measure service availability and capability for this network

Conduct sensitivity analysis for incremental service options

Use cost and revenue associated with each option

Finalize the plan

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Threshold service level is customer service associated with the least-total-cost-system

Existing policies of availability and capability are often assumed as the threshold service level
Current performance provides starting point for potential service improvements

Result of a customer service availability analysis is shown in Figure 12.7 for warehouses X, Y and Z
Based on distribution of an average order Delivery time is estimated on the basis of distance Transit inventory estimated based on delivery time

Management can make basic customer delivery commitments of the basic service platform
Use an estimate of expected order cycle time
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Illustration of total logistics cost for three warehouse locations

Figure 12.7 Determination of Service Territories: Three-Point, Least-Cost System

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Service sensitivity analysis uses the threshold service level to evaluate potential changes Basic service capabilities of a network change with variations in
Number of warehouses
Adding warehouses increases fixed costs

Performance cycles
E.g. web-based ordering, premium transportation Typically increases variable costs

Safety stock policy

Increase in SS will shift average inventory cost curve upward

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Variations in the number of warehouse locations is illustrated in Table 12.5 in the text
Key points from this table
Incremental service is a diminishing function High degrees of service are achieved much faster for longer performance intervals than for shorter intervals Total cost increases dramatically with each location added to the logistical network

Portfolio effect is the relationship between uncertainty and required inventory Portfolio effect can be estimate using the square root rule

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Finalizing strategy requires evaluating the incremental service cost vs. incremental revenue
Figure 12.9 illustrates an example
Marketing proposes
2% improvement in inventory availability 36-hour improvement in delivery capability

Design analysis determines a 12 warehouse lowest-cost network is needed

Incremental total cost to achieve proposed option = $400k per year Incremental revenue needed to break even = $4million per year
Assumes 10% profit margin

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Figure 12-8 Comparative total cost for 5- and 12-distribution point systems

Figure 12.8 Comparative Total Cost for 5- and 12- Distribution-Point Systems
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Logistics system design requirements

Commodity
Direct bulk or crossdock delivery Limited product requirements Unique information requirements and capabilities Precise management requirements

Integrated Service Customized Service

Delivery to customer DC Broad product offering Range of information requirements and capabilities Accept more generic strategies

Delivery in small quantities Select products Tracking of individual behavior Individual focused strategies

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Mass merchant comparison

Target
New and unique product offerings Maintain inventory responsibility Maintain forecasting

Wal*Mart
Low cost product Shift inventory management to vendor Collaborative forecasting

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Fuel price changes

U.S. DIESEL FUEL PRICES SINCE 1999 (in USD per gallon) (Source:U.S. Department of Energy)

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Optimal number of distribution centers by fuel price

(Non-production costs in 000 USD)
52,000 50,000 Base 25% Increase 50% Increase 100% Increase

Total Cost

48,000 46,000 44,000 42,000 40,000 5 6 7 8 9 10 11 Number of Distribution Centers

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Supply chain design criteria

Design to minimize landed cost Design to maximize asset utilization Design to maximize competitive positioning (relevancy) Design to minimize risk Design to maximize control

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Grocery Channel Economics

Traditional Model
Distributor/Retail Warehouse

1 CPU Plant

CPU Warehouse

Store
Back Room Shelf

C&S Vision
ES3 Warehouse
CPU Plant C&S Case Pick

Store Aisle

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Sustainable Supply Chain Strategy

Key Elements relating to supply chain sustainability
Supply Chain Redesign - Reduce the number of shipments and container-miles for highly hazardous materials 1. Supply Chain Visibility - Improve visibility of shipments through implementation of RFID and GPS technologies 2. Shipping Container Design - Improve container design to prevent tampering and to reduce the potential for product releases due to accidents or security incidents 3. Enhanced Collaboration Enhance collaboration with carriers and local communications to improve emergency preparedness and response should a product release occur
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Supply Chain Design Criteria

1990
Demand Production Material Transportation

2012
Demand Sustainability
Energy Labor Political

Taxation Transportation Production Material

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Supply Chain Design Criteria

1990
Demand Production Material Transportation

2012
Demand Sustainability
Energy Labor Political Regulations Debtors Supplier relationships Commodity availability Cross-sale requirements

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Taxation (TASC) Transportation Production Material

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