Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved McGraw-Hill/Irwin CHAPTER 12: Network Design
Nov 11, 2014
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CHAPTER 12: Network Design
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• Enterprise facility network• Warehouse requirements• Systems concept and
analysis• Total cost integration• Formulating logistical
strategy
Network design overview
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• 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
Enterprise facility network
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• 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
Spectrum of location decisions exists but chapter focus is on selecting warehouse locations
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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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• 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
Warehouse requirements
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• 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
Procurement drivers help purchase materials and components at the lowest total inbound cost
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• 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
Manufacturing drivers help consolidate finished product for outbound customer shipment
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• 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
Customer accommodation drivers provide custom inventory assortments to wholesalers/retailers
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• Must achieve freight consolidation with warehouse positioning– Inventory storage to
support customized orders– Mixing facilities to support
flow-through and cross-dock sorting
Warehouse justification is based on providing a service or cost advantage from their location
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• 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?
Key design questions to ask when developing a logistics network
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• 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
The “Systems” Concept
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• 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
Systems analysis seeks to quantify trade-offs between logistics functions
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• Total system performance is singularly important• Individual components don’t 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
Principles of general systems theory
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• 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
A systems concept example
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• 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
Total cost integration
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• 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
Transportation economics
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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
– Local delivery within market = $1.35 per cwt
• 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
• Can you justify the use of a warehouse in this situation?
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• Basic economies– Economy of size (quantity discount)– Economy of distance (tapering principle)
• Activity based cost– Loading and unloading– Movement– Information
• Generalized relationship
Transportation cost Integration (Spatial)
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Transport Cost
Number of Distribution Locations
Outbound
Inbound
Total Transport
Transport cost as a function 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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• Performance cycle is key driver
• Forward deployment of inventory potentially improves service response time, but– Increases overall system
inventory
Inventory economics is driven by service response time
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• 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?
Service-based warehouse justification
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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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• 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
What about the impact on safety stock?
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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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• 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
Inventory summary
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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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• 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
Total cost of the network is illustrated in Figure 12.6
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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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$-
$10
$20
$30
$40
$50
$60
$70
$80
$90
0 2 4 6 8 10
Number of Warehouses
Co
st
(mill
ion
s $
)
Total Cost
Transportation Cost
Fixed Cost
Inventory Cost
Minimize the cost of your logistics network without compromising your service levels
Optimal Number
of Warehouses
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LogicNet Case Study:Current Network for MetalWorks
DC’s• Dover
• Des Moines
Plants• Dover
• Des Moines
Customers are sized by demand
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LogicNet Case Study:Current Network for MetalWorks
Total Cost: $69,500,000Average Distance to Customers: 750 Miles
DC’s• Dover
• Des Moines
Plants• Dover
• Des Moines
Indicators show utilization of DC’s
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• 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
Assumptions are important to understand for their impact on finalizing a strategy
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• 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
Limitations to accurate total cost analysis
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• 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
Formulating logistical strategy requires evaluating alternative customer service levels and costs
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• 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
Threshold service level is customer service associated with the least-total-cost-system
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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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• 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
Service sensitivity analysis uses the threshold service level to evaluate potential changes
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• 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
Variations in the number of warehouse locations is illustrated in Table 12.5 in the text
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• 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
Finalizing strategy requires evaluating the incremental service cost vs. incremental revenue
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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 Integrated Service Customized Service
Direct bulk or crossdock delivery
Limited product requirements
Unique information requirements and capabilities
Precise management requirements
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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40,000
42,000
44,000
46,000
48,000
50,000
52,000
5 6 7 8 9 10 11
Number of Distribution Centers
To
tal C
os
t Base
25% Increase
50% Increase
100% Increase
Optimal number of distribution centers by fuel price
(Non-production costs in 000 USD)
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• Design to minimize landed cost• Design to maximize asset utilization• Design to maximize competitive positioning
(relevancy)• Design to minimize risk• Design to maximize control
Supply chain design criteria
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Grocery Channel Economics
CPU WarehouseDistributor/
Retail Warehouse
Store
ES3 Warehouse
C&S Case Pick
Store Aisle
• Traditional Model
• C&S Vision
1 CPU Plant Back Room Shelf
CPU Plant
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Key Elements relating to supply chain sustainabilitySupply Chain Redesign - Reduce the number of shipments
and container-miles for highly hazardous materials1. Supply Chain Visibility - Improve visibility of shipments
through implementation of RFID and GPS technologies2. 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
Sustainable Supply Chain Strategy
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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
– Taxation (TASC)– Transportation– Production– Material