Supply Chain Management (3rd Edition

Chapter 5 Network Design in the Supply Chain

© 2007 Pearson Education


A strategic framework for facility location Multi-echelon networks Gravity methods for location Plant location models

© 2007 Pearson Education


Network Design Decisions
Facility role: function and processes in each facility Facility location: where Capacity allocation; capacity of each one Market and supply allocation: what markets will
serve, and which supply sources should feed.

© 2007 Pearson Education


Factors Influencing Network Design Decisions Strategic factors Technological factors Macroeconomic factors Political factors Infrastructure factors Competitive factors Logistics and facility costs factors © 2007 Pearson Education 5-4 .

Offshore Facility: Low-cost facility for export production. The location selected for an offshore facility should have low labor and other costs to facilitate low-cost production.1 1. An offshore facility serves the role of being a low-cost supply source for markets located outside the country where the facility is located. Kasra Ferdows (1997) suggests the following classification of possible strategic roles for various facilities in a global supply chain network.Strategic factors  It is important for a firm to identify the mission or strategic role of each facility when designing its global network. they are preferred sites for offshore manufacturing facilities. © 2007 Pearson Education . Given that many Asian developing countries waive import tariffs if all the output from a factory is exported.

A server facility's objective is to supply the market where it is located. Server Facility: Regional production facility. A good example is Nike's plant network in Korea and Taiwan. local content requirement. A source facility is often a primary source of product for the entire global network. A server facility is built because of tax incentives. Suzuki partnered with the Indian government to set up Maruti Udyog. tariff barriers. Source Facility: Low-cost facility for global production. Initially. Maruti was set up as a server facility and only produced cars for the Indian market. In the late 1970s. © 2007 Pearson Education . however. these plants have become more involved with new product development and manufacture some products for sale all over the world. or high logistics cost to supply the region from elsewhere. infrastructure is well developed. but its strategic role is broader than that of an offshore facility. and a skilled workforce is available. The Maruti facility allowed Suzuki to overcome the high tariffs for imported cars in India. Over time. 3. Plants in both countries started out as offshore facilities because of low labor costs. Source facilities tend to be located in places where production costs are relatively low. A source facility also has low cost as its primary objective.2. Good offshore facilities migrate over time into source facilities.

Lead Facility: Facility that leads in development and process technologies.4." Harvard Business Review (March-April). Given its location. 5. it also plays the role of a server facility. "Making the Most of Your Foreign Factories. Contributor Facility: Regional production facility with development skills. Many global firms have production facilities located in Japan in spite of the high operating costs. 1997. Outpost Facility: Regional production facility built to gain local skills. product modifications. Most of these serve as outpost facilities. IKasra Ferdo\Vs. Most well-managed server facilities become contributor facilities over time. Lead facilities are located in areas with good access to a skilled workforce and technological resources. © 2007 Pearson Education . or product development. The Maruti facility in India today develops many new products for both the Indian and the overseas markets and has moved from being a server to a contributor facility in the Suzuki network. A lead facility creates new products. processes. The primary objective remains one of being a source of knowledge and skills for the entire network. and technologies for the entire network. 6. A contributor facility serves the market where it is located but also assumes responsibility for product customization. process improvements. An outpost facility is located primarily to obtain access to knowledge or skills that may exist within a certain region.

it becomes easier to consolidate manufacturing in a few large facilities. a firm has to set up local facilities to serve the market in each country.  In contrast. © 2007 Pearson Education . . each serving its local market. To reduce transportation costs. Coca-Cola sets up many bottling plants all over the world. and each one they build has a very large capacity. This is the case in the manufacture of computer chips where factories require a very large investment. If the production technology is very inflexible and product requirements vary from one country to another. If production technology displays significant economies of scale. many local facilities are preferred because this helps lower transportation costs. As a result. if the technology is flexible. bottling plants for Coca Cola do not have a very high fixed cost. if facilities have lower fixed costs. For example. most companies build few chip production facilities. Conversely.  Flexibility of the production technology impacts the degree of consolidation that can be achieved in the network.Technological Factors Characteristics of available production technologies have a significant impact on network design decisions. few high-capacity locations are the most effective.

Thus. As trade has increased and markets have become more global. tariffs. it is imperative that firms take these factors into account when making network design decisions © 2007 Pearson Education . exchange rates.Macroeconomic Factors Macroeconomic factors include taxes. and other economic factors that are not internal to an individual firm. macroeconomic factors have had a significant influence on the success or failure of supply chain networks.

and regional agreements like NAFTA (North America) and MERCOSUR (South America). which assembles the Z3. and cities often provide to encourage firms to locate their facilities in specific areas. state. As tariffs have come down with the World Trade Organization. General Motors built its Saturn facility in Tennessee primarily because of the tax incentives offered by the state. mainly because of the tax incentives offered by South Carolina © 2007 Pearson Education . High tariffs lead to more production locations within a supply chain network. companies either do not serve the local market or set up manufacturing plants within the country to save on duties. a decrease in tariffs has led to a decrease in the number of manufacturing facilities and an increase in the capacity of each facility built. Tax incentives are a reduction in tariffs or taxes that countries. Many countries vary incentives from city to city to encourage investments in areas with lower economic development.Tariffs and Tax Incentives Tariffs refer to any duties that must be paid when products and/or equipment are moved across international. Tariffs have a strong influence on location decisions within a supply chain. firms have begun to consolidate their global production and distribution facilities. with each location having a lower allocated capacity. For global firms. Similarly. If a country has very high tariffs. states. firms can now supply the market within a country from a plant located outside that country without incurring high duties. or city boundaries. BMW built its factory. Such incentives are often a key factor in the final location decision for many plants. As a result. in Spartanburg.

Suitably designed supply chain networks.Exchange Rate and Demand Risk  Fluctuation in exchange rates has a significant impact on the profits of any supply chain serving global markets. In the 1980s. an increase in the value of the Yen increases the production cost in dollars. Firms that had plants with little flexibility saw a lot of un utilized capacity in their Asian plants.  Exchange rate risks may be handled using financial instruments that limit. however. offer the opportunity to take advantage of exchange rate fluctuations and increase profits.  Companies must also take into account fluctuations in demand caused by fluctuations in the economies of different countries. For example. The appreciation of the Yen decreased their revenues and they saw their profits decline. the loss due to fluctuations. many Japanese manufacturers faced this problem when the Yen appreciated in value. An effective way to do this is to build some over-capacity in the network and make the capacity flexible so that it can be used to supply different markets. Thus. Firms with greater flexibility in their manufacturing © 2007 Pearson Education facilities were able to use the extra capacity in their Asian plants to . Most Japanese manufacturers have responded by building production facilities all over the world. A firm that sells its product in the United States with production in Japan is exposed to the risk of appreciation of the Yen. the Asian economy slowed down between 1996 and 1998. decreasing the firm's profits. TIlis flexibility allows the firm to alter production flows within the supply chain to produce more in facilities that have a lower cost based on current exchange rates. At that time most of their production capacity was located in Japan and they served large markets overseas. or hedge against. The cost of production is incurred in Yen whereas revenues are obtained in dollars.

Political Factors The political stability of the country under consideration plays a significant role in the location choice. This makes it easier for companies to invest in facilities in these countries. Companies prefer to locate facilities in politically stable countries where the rules of commerce are well defined. Countries with independent and clear legal systems allow firms to feel that they have recourse in the courts should they need it. © 2007 Pearson Education .

proximity to transportation terminals. Key infrastructure elements to be considered during network design include availability of sites. How the firms compete and whether external factors such as raw material or labor availability force them to locate close to each other influence this decision. rail service. A fundamental decision firms make is whether to locate their facilities close to competitors or far from them. and location when designing their supply chain networks.  Competitive Factors  Companies must consider competitors' strategy. Infrastructure Factors  The availability of good infrastructure is an important prerequisite to locating a facility in a given area. labor availability. Poor infrastructure adds to the cost of doing business from a given location. proximity to airports and seaports. highway access. and local utilities. congestion. Tianjin. or GuangZhou. even though these locations do not have the lowest labor or land cost because of better infrastructure at these locations. Global companies have located their factories in China near Shanghai. size. © 2007 Pearson Education .

© 2007 Pearson Education . In India. for example.Positive Externalities between Firms Positive externalities are instances where the collocation of multiple firms benefits all of them. Suzuki was the first foreign auto manufacturer to set up a manufacturing facility. Suzuki's competitors have also built assembly plants there. Given the well-established supplier base in India. For example. increasing demand for all stores located there. Another example of positive externality is when the presence of a competitor leads to the development of appropriate infrastructure in a developing area. The company went to considerable effort and built a local supplier network. competing retail stores make it more convenient for customers who need only drive to one location and find everything they are looking for. thus benefiting all parties. gas stations and retail stores tend to locate close to each other because doing so increases the overall demand. This increases the total number of customers who visit the mall. Positive externalities lead to competitors locating close to each other. By locating together in a mall. because they now find it more effective to build cars in India rather than import them to the country.

A customer goes to the closest firm and customers that are equidistant from the two firms are evenly split between them. Consider a situation where customers are uniformly located along the line segment between 0 and 1 and two firms compete based on their distance from the customer as shown in Figure 5. © 2007 Pearson Education .1. they can maximize market share by locating close to each other and splitting the market.2 When firms do not control price but compete on distance from the customer. firms locate to be able to capture the largest possible share of the market. A simple model first proposed by Hotelling explains the issues behind this decision.Locating to Split the Market When there are no positive externalities.

This set of locations. is given by 1 b  a 1 b  a d1  a  and d 2  2 2 Clearly. however. the average distance customers have to travel drops to 1/8. gives both firms an incentive to try and increase market share by moving to the middle.b. both firms maximize their market share if they move closer to each other and locate at a = b = 1/2. the average distance that customers have to travel is 1/4. Observe that when both firms locate in the middle of the line segment.If total demand is 1 and Firm 1 locates at point a and Firm 2 locates at point 1 . d1 and d2. If one firm locates at 1/4 and the other at 3/4. The result of competition is for both firms to locate close together even though doing so increases the average distance to the customer. the demand at the two firms. © 2007 Pearson Education .

inventory. support required. EXCHANGE RATE AND DEMAND RISK PHASE III Desirable Sites PRODUCTION METHODS Skill needs. flexibility PHASE I Supply Chain Strategy TARIFFS AND TAX INCENTIVES COMPETITIVE ENVIRONMENT PHASE II Regional Facility Configuration REGIONAL DEMAND Size. growth strategy. site specific AVAILABLE INFRASTRUCTURE PHASE IV Location Choices LOGISTICS COSTS Transport. coordination © 2007 Pearson Education 5-17 . growth. materials.A Framework for Global Site Location Competitive STRATEGY GLOBAL COMPETITION INTERNAL CONSTRAINTS Capital. response time FACTOR COSTS Labor. existing network PRODUCTION TECHNOLOGIES Cost. homogeneity. local specifications POLITICAL. Scale/Scope impact.

Phase I: Define a Supply Chain Strategy The objective of the first phase of network design is to define a firm's supply chain strategy. managers must determine the supply chain strategy for the firm. building new facilities. or partnering. Based on the competitive strategy of the firm. The supply chain strategy specifies what capabilities the supply chain network must have to support a firm's competitive strategy (see Chapter 2). any economies of scale or scope. Managers must also identify constraints on available capital and whether growth will be accomplished by acquiring existing facilities. Phase I starts with a clear definition of the firm's competitive strategy as the set of customer needs that the supply chain aims to satisfy. © 2007 Pearson Education . Next. an analysis of the competition. and any constraints. managers must forecast the likely evolution of global competition and whether competitors in each market will be local or global players.

Homogenous requirements favor large consolidated facilities whereas requirements that vary across countries favor smaller. An analysis of Phase II is started with a forecast of the demand by country.Phase II: Define the Regional Facility Configuration The objective of the second phase of network design is to identify regions where facilities will be located. localized facilities. If economies of scale or scope are significant. For example. Coca Cola has bottling plant in every market that it serves because the manufacturing technology does not include large economies of scale. If economies of scale or scope are not significant. and their approximate capacity. © 2007 Pearson Education . Semiconductor manufacturers like Motorola. their potential roles. Such a forecast must include a measure of the size of the demand as well as a determination of whether the customer requirements are homogenous or variable across different countries. it may be better to have a few facilities serving many markets. in contrast have very few plants for their global markets given the economies of scale in production. The next step is for managers to identify whether economies of scale or scope can playa significant role in reducing costs given available production technologies. it may be better for each market to have its own facility.

tax incentives. and any export or import restrictions for each market. regions where facilities will be set up. managers must identify demand risk. The desired response time for each market must also be identified. The regional configuration defines the approximate number of facilities in the network. The tax and tariff information is used to identify the best location to extract a major share of the profits. exchange rate risk.  Based on all this information. Managers must also identify the factor and logistics costs at an aggregate level in each region. any requirements for local production. Managers must identify competitors in each region and make a case for whether a facility needs to be located close to or far from a competitor's facility. managers will identify the regional facility configuration for the supply chain network using network design models discussed in the next section. They must also identify regional tariffs. and political risk associated with different regional markets.© 2007 Pearson Education Next. and whether a facility will produce all products for a given market or a few .

Soft infrastructure requirements include the availability of skilled workforce. The set of desirable sites should be larger than the desired number of facilities to be set up so that a precise selection may be made in Phase IV. Hard infrastructure requirements include the availability of suppliers.Phase III: Select Desirable Sites The objective of Phase III is to select a set of desirable sites within each region where facilities are to be located. utilities. Sites should be selected based on an analysis of infrastructure availability to support the desired production methodologies. and warehousing infrastructure. communication. workforce turnover. and the community © 2007 Pearson Education receptivity to business and industry. transportation services. .

and the taxes and tariffs at each location. In the next section we discuss methodologies for making facility location and capacity allocation decisions during Phase II and Phase IV.Phase IV: Location Choices The objective of this phase is to select a precise location and capacity allocation for each facility. various logistics and facility costs. The network is designed to maximize total profits taking into account the expected margin and demand in each market. © 2007 Pearson Education . Attention is restricted to the desirable sites selected in Phase III.

Conventional Network Vendor DC Materials DC Finished Goods DC Customer DC Customer Store Vendor DC Component Manufacturing Plant Warehouse Components DC Customer DC Customer Store Customer Store Customer Store Customer DC Customer Store 5-23 Vendor DC Final Assembly © 2007 Pearson Education Finished Goods DC .

Tailored Network: Multi-Echelon Finished Goods Network Regional Finished Goods DC Local DC Cross-Dock Customer 1 DC Local DC Cross-Dock Customer 2 DC Local DC Cross-Dock Store 1 Store 1 Store 2 Store 2 Store 3 Store 3 National Finished Goods DC Regional Finished Goods DC © 2007 Pearson Education 5-24 .

yn : Coordinates of delivery location n d – dn : Distance to delivery location n – Fn : Annual tonnage to delivery location n Min  d n Dn F n ( x  x n)  ( y  y n) D nx F  d x D nF  d D ny F  d y D nF  d n  2 2 k n n n 1 n k n n 1 n k n n n 1 n k n n 1 n © 2007 Pearson Education 5-25 .y: Warehouse Coordinates – xn.Gravity Methods for Location Ton Mile-Center Solution – x.

Network Optimization Models Allocating demand to production facilities Locating facilities and allocating capacity Key Costs: • Fixed facility cost • Transportation cost • Production cost • Inventory cost • Coordination cost Which plants to establish? How to configure the network? © 2007 Pearson Education 5-26 .

. x i 1 m j 1 n ij  D j .m i x  K ij .... i  1...t. j  1.Demand Allocation Model Which market is served by which plant? Which supply sources are used by a plant? xij = Quantity shipped from plant site i to customer j Min cij xij i 1 j 1 n m s..n x ij 0 © 2007 Pearson Education 5-27 ..

m i 1 n ij j n  x  K y .. y {0..Plant Location with Multiple Sourcing yi = 1 if plant is located at site i. 0 otherwise xij = Quantity shipped from plant site i to customer j Min i 1 n f y   c x i i i 1 j 1 ij n m ij s...t.1} i 1 i i © 2007 Pearson Education 5-28 .. j  1..n j 1 m ij i i  y  k .  x  D . i  1...

.Plant Location with Single Sourcing yi = 1 if plant is located at site i. 0 otherwise xij = 1 if market j is supplied by factory i. y {0...t.n ij i i xij. i  1.. x i 1 n j 1 n ij  1. 0 otherwise Min i 1 n f y   D j c x i i i 1 j 1 ij n m ij s... j  1.m  D j x  K y ...1} i © 2007 Pearson Education 5-29 .

How are the following optimization methods used for facility location and capacity allocation decisions? – Gravity methods for location – Network optimization models © 2007 Pearson Education 5-30 .Summary of Learning Objectives What is the role of network design decisions in the supply chain? What are the factors influencing supply chain network design decisions? Describe a strategic framework for facility location.

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