Chapter 2-Distribution Network Design

Course:
LOGISTICS ENGINEERING AND SUPPLY

CHAIN DESIGN
International University
Vietnam National University HCMC
Chapter 2
Designing Distribution Networks &
Applications to Omni-channel Retailing
Lecturer: Dr. Nguyễn Hằng Giang Anh

Email: nhganh@hcmiu.edu.vn
Learning Objectives
❖ Identify the key factors to be considered when designing a

distribution network.
❖ Discuss the strengths and weaknesses of various distribution
options.
❖ Describe how to select a Distribution Network Design
Main Contents
1. Key Factors Affecting Distribution Network Design in the SC
2. Distribution Network Configurations
3. Selecting a Distribution Network Design
o Comparable performance over six network designs

o Network options for product/ customer characteristics
o Centralized vs. decentralized network design – game theory
approach
1.
KEY FACTORS
AFFECTING
DISTRIBUTION
NETWORK DESIGN
Role of Distribution
• Distribution – the steps taken to move move store

and store a
product from the supplier customer stage
supply stagestage to the customer stage in
a supply chain.
• Distribution drives profitability to a firm by directly
affecting supply chain cost cost and the customer
value/experience.
value/experience
• Appropriate distribution network can achieve a variety of

supply chain objectives from low low cost cost to high
high responsiveness
responsiveness → variety of distribution network
choices. S M C
sc upstream Downstream
logistic inbound outbound
Distribution front end
Example - Distribution Network Choices
• Distribute its PCs directly to end consumers so customers waited
several days to get a PC.
Dell
• Until 2007, Dell also started selling its PCs through retailers such
as Walmart.
• Distribute through resellers so customers could walk away with an
HP
HP computer from a reseller wihout waiting.
• Distribute directly to large supermarket chains while obligating

P&G
smaller players to buy P&G products from distributors
• Stock about 400,000 SKUs that can be sent to customers within a

day of order placement.
W.W.
• Remaining slower-moving products are shipped directly from the
Grainger
manufacturer when a customer places an order. It takes several
days for the customer to receive the product in such cases.
→ Firms have many options when designing their distribution networks. An

inappropriate network can have a significant negative effect on the profitability of
the firm, as isUniversity
International evident in the failure of companies such as Blockbuster and
Webvan.
Process of Designing a Distribution Network
Process of designing a distribution network has two phases:

• In the first phase, the broad structure of the supply chain
network is visualized → This phase decides the number
of stages in the supply chain and the role of each stage.
• The second phase then takes the broad structure and
converts it into specific locations and their capability,
capacity, and demand allocation.
Performance of a Distribution Network
• Distribution network performance is evaluated along two

dimensions:
1. Value provided to the customer
2. Cost of meeting customer needs
• Evaluate the impact on customer service and cost → for

different distribution network options.
• Profitability of the delivery network is determined by
revenue from meeting customer needs and network
costs.
Factors Influencing Distribution Network Design
Customer Value/Service is influenced by the structure of

the distribution network:
• Response time
• Product variety
• Product availability
• Customer experience
• Time to market
• Order visibility
• Returnability
Factors Influencing Distribution Network Design
Supply chain costs are affected by network structure:

• Inventory
• Transportation
• Facilities
• Information
Desired Response Time vs. Number of Facilities
Inventory Costs vs. Number of Facilities
Facility Costs vs. Number of Facilities
Transportation Costs vs. Number of Facilities
• Inbound transportation costs: the costs

incurred to bring material into a facility.
• Outbound transportation costs: the
costs of sending material out of a facility.
Logistics Cost, Response Time vs. Number of Facilities
• Total logistics costs are the sum of

inventory, transportation, and facility
costs for a supply chain network.
→ Each firm should have at least the number of facilities that minimizes
total logistics costs.
→ If International
a firm wants to reduce the response time to its customers → increase
University
the number
Vietnam ofUniversity
National facilities beyond the point that minimizes logistics costs.
HCMC
2.
DISTRIBUTION
NETWORK
CONFIGURATIONS
Design Options for a Distribution Network
• Various distribution network choices from the

manufacturer to the end consumer.
• Two key decisions needed:
1. Will product be delivered to the customer location or picked
up from a prearranged site?
2. Will product flow through an intermediary (or intermediate

location)?
Design Options for a Distribution Network
• Six distinct distribution network designs are classified:

1. Manufacturer storage with direct shipping
2. Manufacturer storage with direct shipping and in-transit merge
3. Distributor storage with carrier delivery
4. Distributor storage with last-mile delivery
5. Manufacturer/distributor storage with customer pickup
6. Retail storage with customer pickup
1. Manufacturer Storage with Direct Shipping
(Drop-shipping) (1/3)
• Example: eBags,
Nordstrom.com,
and W.W. Grainger
• In most cases,
drop-shipping is
used to deliver slow
moving items to
customers.
• Advantage: Centralize inventories at the manufacturer → aggregate demand

across all retailers → high level of product availability with low inventory.
• Issue: Ownership structure of the inventory at the manufacturer
• Application: High-value,
Vietnam National low
University HCMC and unpredictable demand.
Service Factor Performance
Response time Long response time of one to two weeks because of

increased distance and two stages for order processing.
Response time may vary by product, thus complicating
receiving.
Product variety Easy to provide a high level of variety.
Product availability Easy to provide a high level of product availability because of
aggregation at manufacturer.
Customer Good in terms of home delivery but can suffer if order from
experience several manufacturers is sent as partial shipments.
Time to market Fast, with the product available as soon as the first unit is
produced.
Order visibility More difficult but also more important from a customer service
perspective.
Returnability Expensive and difficult to implement.
Cost Factor Performance
Inventory Lower costs because of aggregation. Benefits of

aggregation are highest for low-demand, high-value items.
Benefits are large if product customization can be
postponed at the manufacturer.
Transportation Higher transportation costs because of increased distance

and disaggregate shipping.
Facilities and handling Lower facility costs because of aggregation. Some saving
on handling costs if manufacturer can manage small
shipments or ship from production line.
Information Significant investment in information infrastructure to

integrate manufacturer and retailer.
and In-Transit Merge (1/3)
• Example: Apple to
serve European
customers that
purchase a
computer along with
accessories.
• Advantage: aggregate inventories and postpone product customization similar

to drop-shipping
• Issue: an increase in coordination is required
• Application: products
Vietnam National with
University HCMC high value whose demand is difficult to forecast
Response time Similar to drop-shipping; may be marginally higher.
Product variety Similar to drop-shipping.
Product availability Similar to drop-shipping.
Customer Better than drop-shipping because only a single

experience delivery has to be received.
Time to market Similar to drop-shipping.
Order visibility Similar to drop-shipping.

Returnability Similar to drop-shipping.
Inventory Similar to drop-shipping.
Transportation Somewhat lower transportation costs than drop-

shipping.
Facilities and handling Handling costs higher than drop-shipping at carrier;

receiving costs lower at customer.
Information Investment is somewhat higher than for drop-

shipping.
3. Distributor storage with carrier delivery (1/3)
• Example: Amazon
and industrial
distributors such as
W.W. Grainger and
McMaster-Carr
• Inventories are held by distributors/retailers in intermediate warehouses

→ Package carriers are used to transport products from the intermediate
location to the final customer.
• Stock only the slow- to fast-moving items at their warehouses, with very-
slow-moving items stocked farther upstream.
Response time Faster than manufacturer storage.
Product variety Lower than manufacturer storage.
Product availability Higher cost to provide the same level of availability as

manufacturer storage.
Customer Better than manufacturer storage with drop-shipping.

experience
Time to market Higher than manufacturer storage.
Order visibility Easier than manufacturer storage.
Returnability Easier than manufacturer storage.
Inventory Higher than manufacturer storage. Difference is

not large for faster moving items but can be large
for very slow-moving items.
Transportation Lower than manufacturer storage. Reduction is

highest for faster moving items.
Facilities and Somewhat higher than manufacturer storage. The

handling difference can be large for very slow-moving items.
Information Simpler infrastructure compared to manufacturer

storage.
4. Distributor storage with Last Mile Delivery (1/3)
• Example:
AmazonFresh,
Peapod, Tesco,
Instacart, and
Google Express
provide last-mile
delivery in the
grocery industry.
• Distributor warehouse is closer to customer and delivery to customer’s

home instead of using a package carrier.
• Distributor storage requires higher level of inventory than the other
options (except for retail stores) because it has a lower level of aggregation.
• Warehouse storage with last-mile delivery is suitable for relatively fast-
moving
Vietnamitems that
National are needed
University HCMC quickly.
Response time Very quick. Same day to next-day delivery.

Product variety Somewhat less than distributor storage with package
carrier delivery but larger than retail stores.
Product availability More expensive to provide availability than any other

option except retail stores.
Customer Very good, particularly for bulky items. Slightly higher
experience than distributor storage with package carrier delivery.
Time to market Less of an issue and easier to implement than

manufacturer storage or distributor storage with
package carrier delivery.
Order visibility Easier to implement than other previous options.
Returnability Harder and more expensive than a retail network.
Inventory Higher than distributor storage with package carrier

delivery.
Transportation Very high cost given minimal scale economies.

Higher than any other distribution option.
Facilities and handling Facility costs higher than manufacturer storage or

distributor storage with package carrier delivery, but
lower than a chain of retail stores.
Information Similar to distributor storage with package carrier

delivery.
5. Manufacturer/ Distributor Storage with
Customer Pickup (1/3)
• Example:
7dream.com and
Otoriyose-bin,
operated by Seven-
Eleven Japan,
Tesco, Walmart,
Home Depot
• Inventory is stored at the manufacturer or distributor but Customers order

online or by phone and pick up at specified points.
• Inventory of fast-moving items at pickup locations, whereas slow-moving
items are stocked
International at a central warehouse or at the manufacturer.
University
Response time Similar to package carrier delivery with manufacturer
or distributor storage. Same-day delivery possible for
items stored locally at pickup site.
Product variety Similar to other manufacturer or distributor storage

options.
Product availability Similar to other manufacturer or distributor storage
options.
Customer Lower than other options because of the lack of
experience home delivery. Experience is sensitive to capability
of pickup location.
Time to market Similar to manufacturer storage options.
Order visibility Difficult but essential.
Returnability Somewhat easier given that pickup location can
handle returns.

Inventory Can match any other option, depending on the
location of inventory.
Transportation Lower than the use of package carriers,

especially if using an existing delivery network.
Facilities and Facility costs can be high if new facilities have

handling to be built. Costs are lower if existing facilities
are used. The increase in handling cost at the
pickup site can be significant.
Information Significant investment in infrastructure required.
6. Retail Storage with Customer Pickup (1/3)
• Example: Home
Depot and Tesco. A
B2B example is
W.W. Grainger
• Inventory is stored locally at retail stores. Customers walk into the retail
store or place an order online or by phone and pick it up at the retail store.
• Inventory of fast-moving items at retail stores, whereas slow-moving items
areInternational
stocked University
at a central warehouse.
Response time Same-day (immediate) pickup possible for items

stored locally at pickup site.
Product variety Lower than all other options.
Product availability More expensive to provide than all other options.
Customer Related to whether shopping is viewed as a positive or
experience negative experience by customer.
Time to market Highest among distribution options.
Order visibility Trivial for in-store orders. Difficult, but essential, for
online and phone orders.
Returnability Easier than other options because retail store can
provide a substitute.
Inventory Higher than all other options.
Transportation Lower than all other options.
Facilities and Higher than other options. The increase in

handling handling cost at the pickup site can be significant
for online and phone orders.
Information Some investment in infrastructure required for

online and phone orders.
3.
SELECTING A
DISTRIBUTION
NETWORK DESIGN
Comparative performance of Delivery Network
Designs
Performance of Delivery Network for Different
Product/Customer Characteristics
→ Most companies are best served by a combination of delivery networks
Centralized vs. decentralized network designs (1/4)
What factors are affected with the decision over centralized or
decentralized management of the distribution network?
Example:
• Consider 2 identical retailers, with the same costs and characteristics, facing random
demand for a single product. We compare the two system, the decentralized and
centralized one. In the centralized pooled system, the retailers together operate a
joint inventory facility and take items out of the pooled inventory to meet demand. In
the decentralized system, each retailer individually orders from the manufacturer to
meet demand.
• We consider a single period of random demand. The probabilistic forecast of demand
faced by each retailer is depicted in the following table. The wholesale price is $80
per unit, the selling price of $125 per unit, salvage value of $20 per unit, and
production cost of $35 per unit. If the order quantity must be multiples of 1,000 units.
→ What’s each retailer’s best order quantity in a period in each system? What is
retailer’s expected profit? Manufacturer’s profit in each system?
Probabilistic demand faced by each retailer
Manufacturer
Demand Probabilistic
8,000 11%
10,000 11%
DC (owned
by retailers) 12,000 28%
14,000 22%
16,000 18%
18,000 10%
Retailers
Customer demand
• To identify the best production quantity, the firm needs to understand the
relationship between the production quantity, customer demand, and profit.
• Suppose the retailer makes order 10,000 units while demand ends at 12,000
units. It is easily verified that
→ That is, Profit =

• On the other hand, if the retailer makes order 10,000 units and demand is only
8,000 units, then
→ That is, Profit =
• Based on the profits calculated at each level of order quantity and

the Probabilistic demand discuss above → we can find the order
quantity that maximizes average profit in both Centralized and
Decentralized strategies.
504,696 2,179,392
Each
Strategy Manufacturer System
retailer
Centralized $500,268 $1,170,000 $2,170,536
Decentralized $470,700 $1,080,000 $2,021,400
→ Since both each retailer and manufacturer earns more

profits in the centralized system, both prefer the centralized
system over decentralized one.
• The previous example makes an important assumption

that does not hold in practice: if a customer arrives when
a retailer does not have inventory, the customer
disappears, and this unit of demand is lost.
• This is clearly not always true. Indeed, loyal customers
faced with no inventory at a dealer will be likely to switch to
another dealer to search whether this dealer has inventory.
• Clearly, the search will have no impact on the centralized
system, since both retailers have access to the same
inventory pool. However, it is intuitive that customer search
will impact the decentralized system.
Impacts on the decentralized system
• What if a retailer knows that his competitors don’t keep enough

inventory, what should he do?
→ Raise the inventory to satisfy: his own demand, and the demand of
customers who initially approach other retailers with limited inventory.
• What if a retailer knows that his competitors keep significant
inventory?
→ Reduce the inventory level, since it’s unlikely to see customers who
switch.
• This question is addressed using concepts from game theory,
and, in particular, the concept of Nash equilibrium.
→ A retailer’s strategy depends on his competitor’s strategy. The two
retailers reach a Nash equilibrium if they both make decisions on the
amount to order that: Neither can improve their expected profits by
changing the order quanttities
Example
• Let’s return to our example. We let 𝛼 represent the percentage

of customers that search the system. Assume that for this
system in 𝛼 = 90%, in the other words, 90% of the customers
who check the other retailer if their demand is not met at the
first retailer. For search level of 90%,
• Please find the unique Nash equilibrium for this system
and then calculate the profits of retailers, manufacturers
and system in the both centralized and decentralized
strategies.
• Which strategy is prefered by the retailers and
manufacturers?

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Course:

LOGISTICS ENGINEERING AND SUPPLY

Lecturer: Dr. Nguyễn Hằng Giang Anh

❖ Identify the key factors to be considered when designing a

1. Key Factors Affecting Distribution Network Design in the SC

2. Distribution Network Configurations

3. Selecting a Distribution Network Design

o Comparable performance over six network designs

• Distribution – the steps taken to move move store

• Appropriate distribution network can achieve a variety of

• Distribute directly to large supermarket chains while obligating

• Stock about 400,000 SKUs that can be sent to customers within a

→ Firms have many options when designing their distribution networks. An

Process of designing a distribution network has two phases:

• Distribution network performance is evaluated along two

2. Cost of meeting customer needs

• Evaluate the impact on customer service and cost → for

Customer Value/Service is influenced by the structure of

Supply chain costs are affected by network structure:

• Inbound transportation costs: the costs

• Total logistics costs are the sum of

• Various distribution network choices from the

2. Will product flow through an intermediary (or intermediate

• Six distinct distribution network designs are classified:

2. Manufacturer storage with direct shipping and in-transit merge

3. Distributor storage with carrier delivery

4. Distributor storage with last-mile delivery

5. Manufacturer/distributor storage with customer pickup

6. Retail storage with customer pickup

• Advantage: Centralize inventories at the manufacturer → aggregate demand

Response time Long response time of one to two weeks because of

Cost Factor Performance

Inventory Lower costs because of aggregation. Benefits of

Transportation Higher transportation costs because of increased distance

Information Significant investment in information infrastructure to

• Advantage: aggregate inventories and postpone product customization similar

Service Factor Performance

Response time Similar to drop-shipping; may be marginally higher.

Product variety Similar to drop-shipping.

Product availability Similar to drop-shipping.

Customer Better than drop-shipping because only a single

Time to market Similar to drop-shipping.

Order visibility Similar to drop-shipping.

Cost Factor Performance

Inventory Similar to drop-shipping.

Transportation Somewhat lower transportation costs than drop-

Facilities and handling Handling costs higher than drop-shipping at carrier;

Information Investment is somewhat higher than for drop-

• Inventories are held by distributors/retailers in intermediate warehouses

Service Factor Performance

Response time Faster than manufacturer storage.

Product variety Lower than manufacturer storage.

Product availability Higher cost to provide the same level of availability as

Customer Better than manufacturer storage with drop-shipping.

Time to market Higher than manufacturer storage.

Order visibility Easier than manufacturer storage.

Returnability Easier than manufacturer storage.

Cost Factor Performance

Inventory Higher than manufacturer storage. Difference is

Transportation Lower than manufacturer storage. Reduction is

Facilities and Somewhat higher than manufacturer storage. The

Information Simpler infrastructure compared to manufacturer

• Distributor warehouse is closer to customer and delivery to customer’s

Service Factor Performance