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www.elsevier.com/locate/dsw

Discrete Optimization

tax structure

Balram Avittathur a, Janat Shah b, Omprakash K. Gupta

c,*

IIM Calcutta, D.H. Road, Joka P.O., Kolkata 700 104, India

IIM Bangalore, Bannerghatta Road, Bangalore 560 076, India

Prairie View A&M University, Prairie View, TX 77446-0638, USA

b

Available online 19 December 2003

Abstract

The central sales tax (CST) in India results in a dierential sales tax structure. This contributes signicantly to

distribution network decisions that build logistics ineciencies in rms operating in India. In this paper, we develop a

model for determining distribution centres (DCs) locations considering the impact of CST. A non-linear mixed integerprogramming problem that is formulated initially is approximated to a mixed integer-programming problem. Using a

numeric example, the eect of CST rates and product variety on DC locations is studied and found to be having impact.

It is felt that the Indian Government proposal to switch over from the present sales tax regime to value added tax (VAT)

regime would signicantly contribute to reducing the logistics ineciencies of Indian rms.

2003 Published by Elsevier B.V.

Keywords: Distribution centres; Location; India; Logistics management; Non-linear mixed integer programming; Taris

1. Introduction

The increase in competition and the swings in

the economy in the last few years are compelling

rms to cut costs and improve customer service.

With induction of technology and best manufacturing practices in the last few years, the scope for

improving eciency within the factory premises

*

E-mail addresses: balram@iimcal.ac.in (B. Avittathur),

janat@iimb.ernet.in (J. Shah), om_gupta@pvamu.edu (O.K.

Gupta).

0377-2217/$ - see front matter 2003 Published by Elsevier B.V.

doi:10.1016/j.ejor.2003.10.012

is quite dierent when it comes to outbound logistics. It still has not received the attention that

manufacturing has been receiving. With growing

explosion of product variety and markets, the

scope for improving outbound logistics eciency

is very high. In the Indian context, it is worth

understanding the impact of the current sales taxes

structure on logistics performance of Indian rms.

According to Raghuram and Rangaraj [1], the

main components of logistics costs in India are

inventory, transportation and warehousing cost.

One of the important drivers of these costs in

India is dierential sales tax, owing to central

192

seven centrally administered territories (Union

Territories). The CST is a tari that is applicable

to inter-state trade. It is payable when trading

goods transaction by a manufacturer to his retailer does not happen in the same state or union

territory. In other words, when a manufacturer

located in State A directly distributes goods to a

retailer in State B, the consignment attracts CST

as well as local sales tax of State B. However, if

the manufacturer distributes goods to the same

retailer from his own distribution centre (DC)

located in State B, only local sales tax of State B

has to be paid. Thus, the sales tax is dierential,

depending on the locations of the DCs. Thus, in

order to avoid paying CST, a rm has to maintain

at least one DC in each state, such that material

ow to the retail outlets in a particular state

happens only from DCs of that state. For instance, let a particular rm have its DCs in

Karnataka and Tamil Nadu states respectively at

Bangalore and Chennai. Imagine the procurement

of material by a retailer at Hosur in Tamil Nadu

state. Hosur is about 40 km from Bangalore and

280 km from Chennai. From logistics eciency

viewpoint, dispatching material from Bangalore

DC would be easier than from Chennai DC.

However, to avoid CST burden, a rm will dispatch material to Hosur from Chennai DC. This

implies that an Indian rm with a national presence will require 35 distribution centres (28 States

plus seven Union Territories), one in each state

and union territory, to avoid coming under the

purview of CST. However, from logistics eciency viewpoint this may not be justied, particularly in states with low sales volumes. Apart

from higher inventory costs and higher warehousing costs, large number of DCs result in

higher co-ordination and establishment (facilities)

costs. This issue is all the more signicant as

companies strive to network their stock-points

using information technology (facilities).

Existing literature does not clearly reveal studies that show the relation between CST structure

in India and logistics eciency of Indian rms.

Shah and Avittathur [2] point to a survey that

puts nished goods inventories of the Indian

manufacturing sector roughly at 40 days in the

reveal that manufacturing sector nished goods

inventories of United States of America has declined progressively during their study horizon

(19611994) and stood roughly at 14 days in

1994. These gures reveal that logistical eciency

of Indian rms is relatively lower than their

counterparts in the US. The CST structure could

be one of the contributors to this relative ineciency.

Arntzen et al. [4] model global supply chain for

Digital Corporation where they explicitly include

taxes, duties and duty draw back. Since dierent

countries have dierent tax structures and rules

regarding local content requirement, global corporations need to build these concerns into their

decision-making. But since their main focus was

to understand time versus cost trade-os, there

were no specic insights on impact of local taxes

on location decisions. Munson and Rosenblatt [5]

suggested an approach by which one can model

local content rule in classical plant location

model. They transform single plant model into

knapsack problem and suggest a solution procedure. They, however, have worked with deterministic demand structure. Drezner [6] has

surveyed the applications and methods for facility

location problems. However, impact of taxation

has not received attention. We are not aware of

any existing study that has explicitly handled issues of safety stock inventory and location issues

while deciding warehouse location. With increasing product proliferation and high demand uncertainty, impact of safety stock has gained lot of

importance.

In this paper, we attempt to develop a model for

determining DC locations considering the impact

of the dierential sales tax. As already described,

there appears to be a trade-o between CST

structure and logistics eciency in the Indian

context. An exercise to optimally determine the

location of DCs will have to consider this tradeo. This basic model can be used to calculate ineciencies in the current CST structure. We hope

to use this base model to suggest alternate modes

of taxation structure, which are likely to be less

inecient from logistics point of view. Firms in

developing countries like India nd that their cost

local tax rules in addition to the contribution by

poor logistics infrastructure. Currently, entire debate in India regarding sales tax rules are based on

power equations among various parties involved.

We attempt to suggest an approach that can

quantify costs and benets of various tax structures and, thus, bring objectivity to the whole debate. In Section 2, we build distribution centre

location model for dierential sales tax. Findings

are provided in Section 3. Discussion and conclusions are provided in Section 4.

Consider the distribution network of an Indian

manufacturing rm with a national presence,

having a manufacturing facility and a central inventory depot attached to it. This inventory point

is referred to as Central Warehouse. The rm

distributes dierent nished goods (referred now

onwards as products) to its retailers through a

network of DCs, located in dierent states and

union territories. To avoid paying CST, at least

one provincial DC has to be set up in each state

and union territory. A term demand point is

dened to describe the aggregation of all retailer

points in a city and its neighbouring areas. The

geographical spread of a demand point cannot

extend to more than one state or union territory.

For each product at each demand point, the demand in any period is denoted by an i.i.d. random

variable that is normally distributed. The periodic

review inventory policy is followed at the DCs.

Every period, the inventories at the DCs are reviewed and safety stock replenished according to

an periodic review order-up-to level policy [7]. The

distribution centre location modelling refers to the

problem of determining those demand points

where DCs should be located with an objective of

minimizing the total of all relevant costs. As demand varies from one period to another, the objective translates to minimization of the average

of total cost per period.

For each DC, the relevant costs considered in

this modelling are xed cost of installing and

193

carrying inventory as safety stock at the DC

(safety stock inventory cost), the average cost of

carrying inventory in transit between Central

Warehouse to the DC (transit inventory cost) and

average cost of transporting material from Central

Warehouse to the DC (transport cost). In addition, two more costs, average extra transport cost

and average additional sales tax, have to be borne

when a DC serves demand points other than the

one in which it is located at. These demand points

are referred to as external demand points. It is

assumed that a demand point can be served by one

DC only. However, a DC can serve more than one

demand point.

The DC xed cost refers to the installation

(apportioned on period basis) and operational

costs that are independent of the volumes dispensed by the DC. Many costs accounted by a

DC, namely property registration, land tax, electricity expense, telephone expense, clerical expense, rent, etc., have a xed component that

is independent of the distribution volume. The

safety stock inventory cost (for periodic review

inventory policy) and the transit inventory cost

are determined as dened by Silver et al. [7, pp.

3132, 282284]. The transport cost is a function

of the product cost, quantity of products transported and distance between Central Warehouse

and the DC. The extra transport cost is the cost

of transporting material from the DC to an external demand point that it serves and is a function of product cost, quantity of products

transported and distance between DC and the

demand point. The additional sales tax is the CST

that has to be borne if a demand point does not

have a DC and has to be served by a DC that is

located in a dierent state or union territory. In

other words, it comes into picture only when a

DC and an external demand point served by it are

not in the same state or union territory. Certain

distribution costs were not considered, as they are

irrelevant to this modelling. They are the cyclic

inventory carrying cost and the direct cost of installing and maintaining DCs. These costs are

directly related to the volumes transacted and do

not dependent on the number of DCs in operation and their locations.

194

follows:

Parameters and subscripts

I

fiji 1; . . . ; pg, set of products;

J

fjjj 1; . . . ; ng, set of demand points;

lij

mean of per period demand of product i

at demand point j;

rij

standard deviation of per period demand

of product i at demand point j;

hi

unit per period inventory carrying rate of

product i;

dk

distance from Central Warehouse to DC

k, where k 2 J ;

djk

distance of demand point j from DC k,

djk 0 for j k;

F

xed cost per period of installing (apportioned) and operating a DC;

lk

transportation lead-time from Central

Warehouse to DC k. It is assumed that

there is no uncertainty in the transportation process and, hence, lk is a constant;

si

unit cost of transportation per unit distance for product i;

ti

unit additional sales tax for product i,

when applicable;

ujk

a binary parameter that indicates whether

additional sales tax is applicable when

demand point j is served by DC k; ujk 1

when applicable and ujk 0, otherwise.

For j k, ujk 0;

z

safety factor value corresponding to target

inventory service level. The target inventory service level is assumed to be same

for all products and all DCs.

Minimize

TCA

2

4 yk F z

X

X s

hi 1 lk

yjk r2ij

i

(

lk

ujk

hi lij dk djk

)

ti lij yjk 5

si lij

Subject to

yk yjk P 0 8j; k;

X

yjk 1 8j;

2

3

formulation

4

q

P

P P

P

The terms F k yk , z i hi k 1 lk j yjk r2ij ,

P P

P P

P P P

P

i hi

k lk

j yjk lij ,

i si

k dk

j yjk lij ,

i si

j

P P P

P

d

y

l

and

t

y

l

in

the

objeck jk jk ij

i i

k

j6k jk ij

tive function, denoted by (1), respectively describe

the DC xed, average safety stock inventory,

average transit inventory, average transport,

average extra transport and average additional

sales tax costs per period. The constraint denoted

by (4) indicates that all the variables in the

model are binary variables. The constraint denoted by (2) indicates that yjk can take value of 1

only if yk is equal to 1. The constraint denoted by

(3) indicates that only one DC serves a demand

point.

This formulation is a non-linear mixed integerprogramming problem (NLMIP) owing to the

average safety stock inventory cost term in the

objective function. As there are n demand points

and as the optimal number of DCs could vary

from 1 to n, it can be seen that subject to constraints denotedP

by (2) and (3), the problem is one

n

n

of evaluating

combinations of yjk .

r1 nCr r

Hence, as n increases the number of combinations

of yjk to be evaluated increases exponentially.

Thus, the NLMIP formulation is analytically

complex to solve for a large value of n.

problem considering all the relevant costs mentioned earlier. This formulation is as shown below:

costs are not considered in (1), a DC located at

demand point j will denitely serve demand point j.

Decision variables

yk

1, if a DC is located at demand point k; 0,

otherwise;

yjk

1, if demand point j is served by DC k; 0,

otherwise.

yk ; yjk 2 0; 1:

195

Subject to

programming formulation

yk yjk P 0 8j; k;

X

yjk 1 8j;

6

7

NLMIP formulation as described above, an alternate mixed integer programming formulation is

proposed. In NLMIP, the average safety stock

inventory

cost term,

which contains the expression

q

P

2

1 lk j yjk rij , makes the objective function

non-linear. The approximate mixed integer programming formulation (AMIP) is developed by

substituting this non-linear term by two linear

terms.

According to Proposition 1, if yk 1, then

yjk 1 for j k. In the alternative approximate

formulation, the average safety stock inventory

cost is dened in a similar manner as the extra

transport cost term. By Proposition 1, yk 1 implies that DC k at the minimum serves at least

demand point k. The average safety stock inventory

cost

p

P for this situation is equal to

z 1 lk i hi rik . This is referred to as base safety

stock inventory cost. A parameter, cjk , is introduced to dene the additional safety stock inventory costs as a result of DC k serving demand

points other than the one where it is located. Accordingly, the sum of additional safety stock inventory costs as a result of DC k serving demand

points other than

the P

one P

where it is located is

p

described by z 1 lk i hi j cjk rij yjk . It may be

noted that cjk 0 for j k.

Accordingly, the AMIP formulation becomes

Minimize

TCB

"(

)

p X

F z 1 lk

hi rik yk

(

z

p X X

1 lk

hi

cjk rij

lk

hi lij dk djk

ujk

X

i

)

ti lij yjk

si lij

yk ; yjk 2 0; 1:

analytically easier to solve than Formulation A

(NLMIP), it has to be remembered that the optimal solution arrived at by the former is only an

approximation of the actual optimal solution. The

error in optimal solution of AMIP will be minimal

if the parameter cjk is selected judiciously.

3. Findings

AMIP as proposed in Section 2 is validated by a

numeric example in this section. In addition, we

also attempt to understand the impact of the important parameters on the DC location decision

through a series of sensitivity analyses using realistic parameter values. The example is based on the

data provided by a consumer durables manufacturer of India. Although, this rm has a national

presence, only the northern region data is used for

simplicity in presentation of results. In this example, the period is considered to be a week.

In the northern region, the rm presently markets 47 products through six demand points

Delhi, Kanpur, Jullunder, Jaipur, Faridabad and

Dehra Dun. Each of these demand points belongs

to dierent states and union territories. For these

six demand points, j 1; . . . ; 6,P

it is observed that

the total sales in value terms

i Vi lij as well as

summations of weekly

demand

standard deviaP

tions in value terms i Vi rij are respectively in the

proportion 0.40:0.16:0.16:0.16:0.08:0.04, where Vi

is the cost of product i. The DCs that serve these

demand points are served by a Central Warehouse

located at Bangalore in South India. In reality, the

xed cost per period of installing (apportioned)

and operating a DC (F ), the inventory service level

considered for all DCs (z), the inventory carrying

rate per week and unit cost of transportation per

kilometre for each product for this rm are respectively 2500 Indian Rupees per week, 95%,

196

(nominal CST rate), 4% and 10%. Depending on

what the product is, the latter two rates are the

rates in eect currently in India.

We developed our own software code for determining the optimal solution for NLMIP. It was

coded in Java programming language. It determines the least cost and the corresponding DC

of the total product cost. The CST rate applicable

is 4% presently. The data pertaining to variables

dk , lk , djk , ujk and cjk are shown in Tables 14.

Detailed discussion and computation of the cjk

values in Table 4 is shown in Appendix B.

We use four rates of CST (representing ti values) for all the sensitivity analyses. They are 0%

Table 1

Demand point specic data

dk (km)

lk (week)

Delhi

Kanpur

Jullunder

Jaipur

Faridabad

Dehra Dun

2050

1

1855

1

2415

1

2000

1

2020

1

2240

1

Delhi

Kanpur

Jullunder

Jaipur

Faridabad

Dehra Dun

0

480

375

260

30

235

480

0

855

520

450

575

375

855

0

635

405

365

260

520

635

0

290

495

30

450

405

290

0

260

235

575

365

495

260

0

Delhi

Kanpur

Jullunder

Jaipur

Faridabad

Dehra Dun

0

1

1

1

1

1

1

0

1

1

1

1

1

1

0

1

1

1

1

1

1

0

1

1

1

1

1

1

0

1

1

1

1

1

1

0

Table 2

Distances matrix (djk values in km)

Delhi

Kanpur

Jullunder

Jaipur

Faridabad

Dehra Dun

Table 3

CST applicability matrix (ujk values)

Delhi

Kanpur

Jullunder

Jaipur

Faridabad

Dehra Dun

Table 4

Additional safety stock inventory proportionality matrix (cjk values)

Demand point j

1

2

3

4

5

6

DC k

Delhi

Kanpur

Jullunder

Jaipur

Faridabad

Dehra Dun

0.000

0.158

0.158

0.158

0.158

0.158

0.399

0.000

0.399

0.399

0.399

0.399

0.399

0.399

0.000

0.399

0.399

0.399

0.399

0.399

0.399

0.000

0.399

0.399

0.451

0.451

0.451

0.451

0.000

0.451

0.474

0.474

0.474

0.474

0.474

0.000

P the feasible solutions. As mentioned earlier, nr1 nCr rn combinations have to be enumerated for NLMIP. For a six

demand point problem (n 6), this corresponds to

217,392 combinations. Each simulation run, for a

specic set of parameter values, took less than a

minute for the six demand point problem when

run on a PC with Pentium 4 processor. The

number of combinations increases to 1.42 1011 ,

2.52 1019 and 2.43 1028 for n 10, 15 and 20,

respectively. Contemporary PCs may nd it dicult to enumerate problems with this many combinations. Hence, for large problems, complete

enumeration may not be a feasible option.

General algebraic modeling system (GAMS)

2.25 is used to determine the solutions as per

AMIP. For a PC with Pentium 4 processor, the

optimal solution for AMIP is obtained in few

seconds time.

The optimal allocations of DCs based on the

parameters valid for this rm, for the dierent

CST rates, are as shown in Table 5. The current

CST rate is 4% and the solution as per AMIP

matches the present practice of the rm of having a

DC at all the six demand points. As can be seen in

Table 5, optimal number of DC locations is quite

sensitive to CST rate. Given that the Government

intends to reduce CST progressively to 0%, this

has strategic implication for most of the rms

operating in Indian market [8].

197

Using simulation we carryout separate sensitivity analyses of dierent parameters with the

CST rate. For each sensitivity analysis, only one

parameter is varied at a time, keeping the other

parameters at a central level. The levels used for

each parameter were such that the range covered a

wide variety of industries. The parameter values

for the rm in the numeric example are used as the

central levels for the parameters that were being

considered in the sensitivity analyses. For each

simulation, the optimal solutions (least total cost

per week and optimal number of DCs) are determined for both NLMIP (using our software code)

and AMIP (using GAMS 2.25). The results are

as shown in Tables 610.

The dierent parameters considered for sensitivity analysis with respect to CST rate are DC

xed cost (Table 6), DC service level (Table 7),

unit transportation cost per km (Table 8), product

variety (Table 9) and demand distribution among

the demand points (Table 10). The results in Tables 610 are represented graphically in Fig. 1ad

(sensitivity of total cost per week) and Fig. 2ad

(sensitivity of number of DCs).

Referring to Fig. 1ad, the total cost per week

increases with increase in parameter value for all

four parameters. It is also seen that for a particular

parameter value, in all four gures, the cost increases as the CST rate increases from 0% to 4%.

Except one simulation (F 4000 in Table 6), the

Table 5

Optimal solutions for the real-life situation

Case

t (%)

1

3

4

4

10

2

2

2

4

3

3

4

4

5

5

TCB

Error

(%)

134,918

134,918

146,408

146,514

0.07

152,507

152,507

152,507

152,507

1, 2, 3,

4, 5, 6

1, 3, 5,

6

1

1

TCA

6

6

Demand points served are described by numbers with 1, 2, 3, 4, 5 and 6 respectively indicating Delhi, Kanpur, Jullunder, Jaipur,

Faridabad and Dehra Dun.

TCA : least total cost per week as per NLMIP (Formulation A).

TCB : least total cost per week as per AMIP (Formulation B).

Error: jTCA TCB j=TCA .

All cost gures are in Indian Rupees.

198

Table 6

CST (t)DC xed cost

Case

1

2

3

4

5

6

7

8

9

10

11

12

t (%)

0

0

0

1

1

1

4

4

4

10

10

10

AMIP

NLMIP

Error (%)

No. of DCs

TCB

No. of DCs

TCA

1000

2500

4000

1000

2500

4000

1000

2500

4000

1000

2500

4000

2

1

1

3

3

2

6

6

5

6

6

6

133,121

134,918

136,418

142,014

146,514

150,121

143,507

152,507

160,754

143,507

152,507

161,507

2

1

1

3

3

2

6

6

5

6

6

6

133,088

134,918

136,418

141,908

146,408

150,088

143,507

152,507

160,646

143,507

152,507

161,507

z (%)

AMIP

0.02

0.00

0.00

0.07

0.07

0.02

0.00

0.00

0.07

0.00

0.00

0.00

Table 7

CST (t)DC service level

Case

1

2

3

4

5

6

7

8

9

10

11

12

t (%)

0

0

0

1

1

1

4

4

4

10

10

10

90.0

95.0

97.7

90.0

95.0

97.7

90.0

95.0

97.7

90.0

95.0

97.7

NLMIP

Error (%)

No. of DCs

TCB

No. of DCs

TCA

1

1

1

3

3

2

6

6

6

6

6

6

132,169

134,918

137,591

142,269

146,514

150,522

146,952

152,507

157,910

146,952

152,507

157,910

1

1

1

3

3

2

6

6

6

6

6

6

132,169

134,918

137,591

142,186

146,408

150,482

146,952

152,507

157,910

146,952

152,507

157,910

4% to 10%.

Referring to Fig. 2a, b and d, the optimal

number of DCs remains same or decreases as the

parameter value increases (DC xed cost, DC

service level and product variety, respectively).

Referring to Fig. 2c, the optimal number of DCs

remains same or increases as the unit transportation cost per kilometre increases. It is also seen

that for a particular parameter value, in all four

gures, the optimal number of DCs increases as

the CST rate increases from 0% to 4%. Except one

simulation (F 4000 in Table 6), the optimal

number of DCs remains same as CST rate increases from 4% to 10%.

0.00

0.00

0.00

0.06

0.07

0.03

0.00

0.00

0.00

0.00

0.00

0.00

products that are similar are combined on the

basis of three existing product attributes and exploded on the basis of a fourth product attribute

that the rm is planning to introduce in future to

boost product variety. By combining the three

existing product attributes, product variety drops

from 47 to 10. By exploding on the fourth product

attribute, the product variety increases from 47 to

70. Further variety on this attribute increases

product variety to 100. Thus, the p values used are

10, 47, 70 and 100.

Referring to Table 10, we do not observe a

specic trend for total cost per week for change in

demand distribution among demand points from

199

Table 8

CST (t)DC unit transportation cost (per km)

Case

1

2

3

4

5

6

7

8

9

10

11

12

13

14

15

16

t (%)

0

0

0

0

1

1

1

1

4

4

4

4

10

10

10

10

s (%)

AMIP

NLMIP

Error (%)

No. of DCs

TCB

No. of DCs

TCA

0.001

0.002

0.003

0.004

0.001

0.002

0.003

0.004

0.001

0.002

0.003

0.004

0.001

0.002

0.003

0.004

1

1

2

2

2

3

3

3

6

6

6

6

6

6

6

6

79,278

134,918

189,426

242,731

93,816

146,514

198,579

250,644

100,647

152,507

204,367

256,227

100,647

152,507

204,367

256,227

1

1

2

2

2

3

3

3

6

6

6

6

6

6

6

6

79,278

134,918

189,393

242,698

93,783

146,408

198,473

250,538

100,647

152,507

204,367

256,227

100,647

152,507

204,367

256,227

AMIP

0.00

0.00

0.02

0.01

0.04

0.07

0.05

0.04

0.00

0.00

0.00

0.00

0.00

0.00

0.00

0.00

Table 9

CST (t)product variety

Case

1

2

3

4

5

6

7

8

9

10

11

12

13

14

15

16

t (%)

0

0

0

0

1

1

1

1

4

4

4

4

10

10

10

10

10

47

70

100

10

47

70

100

10

47

70

100

10

47

70

100

NLMIP

Error (%)

No. of DCs

TCB

No. of DCs

TCA

1

1

1

1

3

3

2

2

6

6

6

6

6

6

6

6

132,602

134,918

137,637

142,673

142,936

146,514

150,581

156,988

147,826

152,507

158,004

168,182

147,826

152,507

158,004

168,182

1

1

1

1

3

3

2

2

6

6

6

6

6

6

6

6

132,602

134,918

137,637

142,673

142,850

146,408

150,541

156,935

147,826

152,507

158,004

168,182

147,826

152,507

158,004

168,182

it is seen that for a particular demand distribution

among demand points, total cost increases as the

CST rate increases from 0% to 4%. The optimal

number of DCs remains same for both demand

distributions. However, it is seen that for a particular demand distribution among demand

points, the optimal number of DCs increases as the

CST rate increases from 0% to 4%.

0.00

0.00

0.00

0.00

0.06

0.07

0.03

0.03

0.00

0.00

0.00

0.00

0.00

0.00

0.00

0.00

seen that average error (dierence in total costs as

per Formulations A and B) in percentage terms is

just 0.01% with highest error value at 0.36%. The

next highest error gure is 0.07%. It can be seen

that the error is zero when DC locations are located either in one demand point or in all the n

demand points (each DC serves only the demand

point where it is located). This is obvious given the

200

Table 10

CST (t)demand distribution across demand points

Case

1

2

3

4

5

6

7

8

t (%)

0

0

1

1

4

4

10

10

Demand

distribution

AMIP

No. of DCs

TCB

No. of DCs

NLMIP

TCA

Error (%)

Varied

Equal

Varied

Equal

Varied

Equal

Varied

Equal

1

1

3

3

6

6

6

6

134,918

134,430

146,514

151,233

152,507

153,621

152,507

153,621

1

1

3

3

6

6

6

6

134,918

134,430

146,408

150,691

152,507

153,621

152,507

153,621

0.00

0.00

0.07

0.36

0.00

0.00

0.00

0.00

170000

150000

130000

0

1000

2000

3000

4000

5000

TCB : least total cost per week as per AMIP.

Error: jTCA TCB j=TCA .

170000

150000

130000

85.0

(a)

t = 0%

t = 1%

t = 4%

90.0

95.0

100.0

DC Service Level %

t = 10%

(b)

t = 0%

t = 1%

t = 4%

t = 10%

170000

270000

220000

170000

120000

70000

0.000

0.001

0.002

0.003

0.004

t = 0%

t = 1%

t = 4%

130000

0

0.005

s%

(c)

150000

20

(d)

t = 10%

40

60

80

100

Product Variety

t = 0%

t = 1%

t = 4%

t = 10%

Fig. 1. (a) Sensitivity with xed cost; (b) sensitivity with service level; (c) sensitivity with unit transportation cost (per km); and

(d) sensitivity with product variety.

shown in Appendix B). The most important result

is that optimal number of DCs is same as per

NLMIP and AMIP for all simulations. Hence,

AMIP is good approximation of NLMIP. As

mentioned earlier, the software code for NLMIP

has been demonstrated by above simulations, the

approximate MIP formulation provides a good

solution and diers from optimal solution on an

average by 0.01%. This is the basis for our plan to

use AMIP for future studies.

6

4

2

0

0

0

1000

2000

3000

4000

5000

85.0

90.0

t = 0%

t = 1%

t = 4%

(b)

t = 10%

6

4

2

0

0.000

95.0

100.0

DC Service Level %

Number of DCs

Number of DCs

(a)

t = 0%

t = 1%

t = 4%

t = 10%

6

4

2

0

0.001

0.002

0.003

0.004

0.005

10

20

30

t = 0%

t = 1%

40

50

60

70

80

90 100

Product Variety

s%

(c)

201

Number of DCs

Number of DCs

t = 4%

t = 10%

(d)

t = 0%

t = 1%

t = 4%

t = 10%

Fig. 2. (a) Sensitivity with xed cost; (b) sensitivity with service level; (c) sensitivity with unit transportation cost (per km); and

(d) sensitivity with product variety.

A model for determining the location of DCs

for dierential sales tax has been developed in this

paper. It is seen that an accurate formulation results in a complex non-linear mixed integerprogramming problem. The optimal solutions for

the approximate mixed integer programming formulation shows results that are very close to the

optimal solutions for the non-linear mixed integer programming formulation. Validation of the

model using a real-life numeric example shows that

the result as per model was same as the real-life

situation. Simulations to understand the impact of

dierent parameters and the CST rate on the DC

location decision are discussed in the following

subsections.

4.1. Eect of DC xed cost

Referring to the objective function, increasing

the DC xed cost term in a minimization problem

would have the eect of reducing the number of

DCs. Our ndings show that as DC xed cost in-

optimal number of DCs decreases or remains

same. For CST of 4% and above, it is seen that the

high sales tax, incurred when a demand point is

served by a DC located in some other demand

point, becomes the dominant cost, which forces a

DC at all demand points. Hence, the rm has a

DC at all demand points except for one case,

where CST 4% and DC xed cost Rupees 4000

per week, for which the optimal number of DCs

turned out to be ve.

4.2. Eect of DC service level

Referring to the objective function, the DC

service level (z) appears in the safety stock inventory term. As the service level required at each DC

increases, the safety stock requirement also increases. Looking at the safety stock inventory expression in the objective function, it is seen that

this cost term can be reduced by pooling demands

at the dierent demand points. Hence, increasing

the DC service level term in a minimization

problem would have the eect of reducing the

202

service level increases, the total cost per week increases and the optimal number of DCs decreases

or remains same. For CST of 4% and above, it is

seen that the high sales tax, incurred when a demand point is served by a DC located in some

other demand point, becomes the dominant cost,

which forces a DC at all demand points for all

three service levels.

and the optimal number of DCs decreases or remains same. For CST of 4% and above, it is seen

that the high sales tax, incurred when a demand

point is served by a DC located in some other

demand point, becomes the dominant cost, which

forces a DC at all demand points.

for both varied and equal demand distribution

across the demand points. The total costs were

almost same except when CST rate was 1%. The

demand distribution across demand points would

impact the safety stock inventory term, though, its

impact may not be signicant. It was not possible

to make rm conclusions on the impact of demand

distribution on the basis of our simulation results.

transportation cost per km (s) appears in the

two transportation cost terms. As s increases,

the transportation costs increases. Looking at the

transportation cost expressions in the objective

function, it is seen that these cost terms can be

reduced if each demand point is served by a DC

located locally (incur no extra transportation

cost). Hence, increasing s in this minimization

problem would have the eect of increasing the

number of DCs. Our ndings show that as s increases, the total cost per week increases and the

optimal number of DCs increases or remains same.

For CST of 4% and above, it is seen that the high

sales tax, incurred when a demand point is served

by a DC located in some other demand point,

becomes the dominant cost, which forces a DC

at all demand points for all four transportation

costs.

4.4. Eect of product variety

As product variety increases, demand at each

demand point further disaggregates. This results in

the increase in demand uncertainty at the product

level, though, demand uncertainty may remain

same at the aggregate level. Thus, the increase in

product variety, or the number of products, will

result in the increase in safety stock inventory cost.

Looking at the safety stock inventory expression in

the objective function, it is seen that this cost term

can be reduced by pooling demands at the dierent

demand points. Hence, increasing the product

variety would have the eect of reducing the

number of DCs. Our ndings show that as product

variety increases, the total cost per week increases

points

As the CST rate increases the number of DCs

required increases. When CST rate is high, the

benet of pooling safety stocks and the reduction

of DC xed cost, owing to lesser number of DCs,

are negated by the high additional sales tax that

has to be borne owing to DCs and their respective

external demand points not being in the same state

or union territory. Hence, we see that for 4% or

10% CST, the rm would locate a DC at all demand points irrespective of the demand serviced.

The only exception was when CST was 4% and the

DC xed cost was highest at Rupees 4000 thousand per week.

Clearly, CST rate is an important driver of the

optimal number of DCs required. In fact, in all

simulations for CST rates of 4% and 10%, except

one where CST was 4% and the DC Fixed Cost

was highest at Rupees 4000 thousand per week, we

nd that change in parameter value has no impact

on the solution. This indicates the dominant eect

of this cost term.

4.7. Managerial implications

The present CST structure in India has dierent rate slabs, starting from 1% to 4% being the

CST of 4% and 10% show that it is economical to

locate DCs at all demand points, irrespective of

the demand serviced. The simulations also reveal

that the central sales tax transaction occurs only

once for the dierent simulations with CST rates

of 4% and 10%. However, for CST rate of 1%,

the optimal number of DCs varies between 2 and

3 in all the simulations. Thus, central sales tax

transaction occurs in all the simulations with CST

rate of 1%. This implies that the Government

receives a higher income through CST when it is

lower at 1%.

For rms, increase in CST rate increases their

total cost as the number of DCs to be located increases. The present CST structure contributes

substantially to high levels of nished goods inventories and logistics costs in India. It is common

knowledge that holding large inventories is highly

detrimental to rms as well as to developing

economies that suer from nancial resources

scarcity. Given the drawbacks of the present system, from a logistics management viewpoint it is

highly worthwhile to search for alternatives that

are much simpler and ecient, while ensuring that

government revenues are maintained. The Indian

Government proposal to switch over from present

sales tax regime to value added tax regime, which

is equivalent to 0% CST rate, in the future is a

positive attempt at addressing the anomalies in the

Indian logistics sector. This would have signicant

impact on the distribution network design for the

Indian companies. As we have shown, based on

product characteristics (value, weight, volume),

product variety and demand variability, the optimal number of distribution centres would vary

from rm to rm. Even though it is possible to

understand how each of these variables aect

network design individually, it is dicult to work

out intuitive solutions for various combinations of

the relevant parameters. Given that the government has announced a time schedule for changes

to the taxation structure [8], it is imperative for

Indian rms to redesign their distribution networks. The comprehensive model proposed in this

paper should provide help to the decision maker in

arriving at the optimal solution for their respective

networks.

203

We have assumed that the service to customers

at the demand points is same irrespective of where

the DCs that serve them are located. For certain

industries, this assumption may not be valid. The

denition of the cjk values as described in Appendix B resulted in negligible dierence between optimal total costs as per NLMIP and AMIP for the

numerical example we used (n 6). Owing to

diculty in obtaining optimal solution, we could

not test the suitability of the cjk denition for

larger problems.

We intend to address these limitations in our

future studies. In addition, we also intend to extend this study to consider change in CST rate

over a period of time. As per the plan of Government of India, the CST rate will be reduced

gradually in stages. Hence, rm needs to work out

an optimal plan to manage the transition, where it

needs to work out the robust solution for optimal

number of depots for each CST rate change.

Acknowledgements

We wish to thank Mr. Amit Gupta, PGP Student, IIM Bangalore for developing the software

code for solving NLMIP in this paper.

Appendix A. Proof of Proposition 1

The objective of this proposition is to prove

whether a DC located at a demand point will serve

it or not. Consider a n demand points example

where a particular demand point can be served

either by a DC located in that demand point or by

a DC located in any of the n 1 other demand

points.

If DC average safety stock inventory costs are

not considered, incremental total cost at DC k that

is incurred due to serving demand point j, TCjk ,

can be represented as

X

TCjk lk

hi lij dk djk

i

X

i

si lij ujk

X

i

ti lij :

A:1

204

respectively be equal to hVi , sVi and tVi , where Vi is

the unit value of product i. Let for demand point

1, TC11 is greater than TC12 , such that

X

Vi li1 :

A:2

a TC11 TC12 =

i

Also, d11 0 and u11 0 as per denitions.

From (A.1) and (A.2)

a l1 l2 h d1 d2 d12 s u12 t:

A:3

TCm1 TCm2 fl1 l2 h d1 dm1 d2 dm2 s

X

um1 um2 tg

Vi lim : A:4

i

TCm1 TCm2 fa dm1 d12 dm2 s

u12 um1 um2 tg

Vi lim :

A:5

It is obvious that dm2 has to be less than or equal

to the sum of d12 and dm1 . It can be seen that the

term (u12 um1 um2 ) is always greater than equal

to zero. When demand points 1, 2 and m are in

dierent states, u12 , um1 and um2 are equal to one.

Hence, u12 um1 um2 1. When demand

points 1 and 2 belong to one state and demand

point m to another state, u12 is equal to 0 while um1

and um2 are equal to one. Hence, u12 um1

um2 0. When demand points 1 and m belong

to one state and demand point 2 to another state,

um1 is equal to 0 while u12 and um2 are equal to

one. Hence, u12 um1 um2 0. When demand

points 2 and m belong to one state and demand

point 1 to another state, um2 is equal to 0 while

u12 and um1 are equal to one. Hence, u12

um1 um2 2. When demand points 1, 2 and m

are in same state, u12 , um1 and um2 are equal to zero.

Hence, u12 um1 um2 0. Thus, u12 um1

um2 is never less than 0. Combining (A.2) and

(A.5)

TCm1 TCm2 > 0

A:6

TC12 > 0. Hence, it is obvious that if DC 1 does

not serve demand point 1 in optimal solution, it

would not be optimal for it to serve any other

demand point. In other words, if a DC is located at

demand point j, it must at least serve demand

point j. That is, if yk 1, then ykk 1.

By Proposition 1, DC k at the minimum serves

at least demand point k. When DC k serves only

demand point k, totalpsafety

stock inventory cost

P

at DC k is equal to z 1 lk i hi rik . Had all the

demand points been served by DC k, the total

safety stock inventory cost at DC k would have

p P q

P 2

been z 1 lk i hi

j rij . Referring to (5), it

can be seen that cjk is introduced to dene the

additional safety stock inventory costs as a result

of DC k serving demand points other than the one

where it is located. It is already seen from (5) that

the additional safety stock inventory cost at DC k

as a result of DC k serving

demandP

point j, where

p

j 6 k, is described by z 1 lk cjk yjk i hi rij . It may

be noted that cjk 0 for j k.

The cjk values used in Table 4 are arrived at by

the following manner:

P 2

P q

i hi

j rij rik

P P

cjk

for all j 6 k

j6k

i hi rij

and

cjk 0

for j k:

safety

stock

p

P inventory cost at DC k is equal to

z 1 lk i hi rik when it serves only

demand point

p P q

P 2

k and is equal to z 1 lk i hi

j rij when it

serves all the demand points.

References

[1] G. Raghuram, N. Rangaraj, Logistics and Supply Chain

Management: Cases and Concepts, Macmillan India Limited, 2000.

[2] J. Shah, B. Avittathur, Improving supply chain performance

through postponement strategy, Management Review 11 (2)

(1999) 513.

[3] S. Rajagopalan, A. Malhotra, Have US manufacturing

inventories really decreased? An empirical study, Manufacturing and Service Operations Management 3 (1) (2001) 14

24.

[4] B.C. Arntzen, G.G. Brown, T.P. Harrison, L.L. Trafton,

Global supply chain management at digital equipment

corporation, Interfaces 25 (1) (1995) 6993.

205

rules on global sourcing decisions, Production and Operations Management 6 (3) (1997) 277290.

[6] Z. Drezner, Facility Location: A Survey of Applications and

Methods, Springer, New York, 1995.

[7] E.A. Silver, D.F. Pyke, R. Peterson, Inventory Management

and Production Planning and Scheduling, third ed., John

Wiley & Sons, New York, 1998.

[8] G.M. Rao, Reform in central sales tax in the context of

VAT, Economic and Political Weekly 38 (7) (2003) 627636.

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