Network Design

Copyright © 2010 by The McGraw-Hill Companies, Inc. All rights reserved.

McGraw-Hill/Irwin

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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 be used 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)

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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 cross-dock 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 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, i.e., synergy!

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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– Based on transportation consolidation

• 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

– 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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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?

• Although available to promise, it cannot be physically accessed!

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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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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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Visualization of solution adding variables shipment size, transportation mode and location

Figure 12.x Three-Dimensional Total Cost Curve

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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 12.8 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