CHAPTER 4:

DISTRIBUTION NETWORK
DESIGN

Mai Thuy Dung, MSc

mtdung@hcmiu.edu.vn
Room A2.603
International University
Vietnam National University HCMC
 CONTENTS

1. The role of distribution in the supply chain

2. Factors influencing distribution network
design
3. Design options for a distribution network
4. Selecting a distribution network design
a. Comparable performance over six network
designs
b. Network options for product/ customer
characteristics
c. Centralized vs. decentralized network
1. THE ROLE OF
DISTRIBUTION
• Distribution – the steps taken to move and
store a product from the supplier stage to
the customer stage in a supply chain
• Drives profitability by directly affecting
supply chain cost and the customer
experience
• Choice of distribution network can achieve
supply chain objectives from low cost to
high responsiveness
 2. FACTORS
INFLUENCING
DISTRIBUTION
NETWORK DESIGN
• Distribution network performance evaluated along
two dimensions
- Customer needs that are met
- Cost of meeting customer needs
• Evaluate the impact on customer service and cost
for different distribution network options
• Elements of customer service influenced by
network structure:
- Response time
- Product variety
- Product availability
- Customer experience
- Order visibility
- Returnability
• Changing the distribution network design affect
supply chain costs:
- Inventories
- Transportation
- Facilities and handling
- Information

Impacts on lead time

Impacts on inventory costs
Impacts on transportation costs
Impacts on facility costs
 3. DESIGN OPTIONS
FOR A DISTRIBUTION
NETWORK
 DESIGN OPTIONS
• Two key decisions when designing a distribution
network:
- Will product be delivered to the customer location
or picked up from a prearranged site?
- Will product flow through an intermediary?
• Six designs:
- Manufacturer storage with direct shipping
- Manufacturer storage with direct shipping and in-
transit merge
- Distributor storage with carrier delivery
- Distributor storage with last-mile delivery
- Manufacturer/distributor storage with customer
MANUFACTURER STORAGE
WITH DIRECT SHIPPING
Cost Performance
Factor
Inventory Lower costs because of risk pool effects.
Benefits of aggregation are highest for
low-demand, high-value items. Benefits
are large if product customization can be
postponed at the manufacturer.
Transportati Higher transportation costs because of
on increased distance and disaggregate
shipping.
Facilities Lower facility costs because of
and centralized management. Some saving
handling on handling costs if manufacturer can
manage small shipments or ship from
production line.
Information Significant investment in information
Service Performance
Factor
Response Long response time of one to two weeks
time because of increased distance and two
stages for order processing.
Product Easy to provide a high level of variety.
variety
Product Easy to provide a high level of product
availability availability because of risk pool effects
at manufacturer.
Customer Good in terms of home delivery but can
experience suffer if order from several
manufacturers is sent as partial
shipments.
Time to Fast, with the product available as soon
market as the first unit is produced.
IN-TRANSIT MERGE NETWORK
Cost Factor Performance
Inventory Similar to drop-shipping.
Transportation Somewhat lower transportation costs
than drop-shipping.

Facilities and Handling costs higher than drop-

handling shipping at carrier; receiving costs
lower at customer.
Information Investment is somewhat higher than
for drop-shipping.
Service Performance
Factor
Response Similar to drop-shipping; may be
time marginally higher.
Product Similar to drop-shipping.
variety
Product Similar to drop-shipping.
availability
Customer Better than drop-shipping because only
experience a single delivery has to be received.
Time to Similar to drop-shipping.
market
Order Similar to drop-shipping.
visibility
DISTRIBUTOR STORAGE WITH
CARRIER DELIVERY
Cost Factor Performance
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
handling storage. The difference can be large
for very slow-moving items.
Information Simpler infrastructure compared to
manufacturer storage.
Service Performance
Factor
Response Faster than manufacturer storage.
time
Product Lower than manufacturer storage.
variety
Product Higher cost to provide the same level
availability of availability as manufacturer
storage.
Customer Better than manufacturer storage with
experience drop-shipping.
Time to Higher than manufacturer storage.
market
Order Easier than manufacturer storage.
visibility
DISTRIBUTOR STORAGE WITH
LAST-MILE DELIVERY
Cost Factor Performance
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 Facility costs higher than
handling 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.
Service Performance
Factor
Response Very quick. Same day to next-day
time delivery.
Product Somewhat less than distributor storage
variety with package carrier delivery but larger
than retail stores.
Product More expensive to provide availability
availability than any other option except retail
stores.
Customer Very good, particularly for bulky items.
experience Slightly higher than distributor storage
with package carrier delivery.
Time to Less of an issue and easier to implement
market than manufacturer storage or distributor
storage with package carrier delivery.
Order Easier to implement than other previous
 MANUFACTURER/ DISTRIBUTOR
STORAGE WITH CUSTOMER PICKUP
Cost Performance
Factor
Inventory Can match any other option, depending
on the location of inventory.
Transportati Lower than the use of package carriers,
on especially if using an existing delivery
network.
Facilities Facility costs can be high if new facilities
and have to be built. Costs are lower if
handling existing facilities are used. The increase
in handling cost at the pickup site can be
significant.
Information Significant investment in infrastructure
required.
Service Performance
Factor
Response Similar to package carrier delivery with
time manufacturer or distributor storage.
Same-day delivery possible for items
stored locally at pickup site.
Product Similar to other manufacturer or
variety distributor storage options.
Product Similar to other manufacturer or
availability distributor storage options.
Customer Lower than other options because of
experience the lack of home delivery. Experience
is sensitive to capability of pickup
location.
Time to Similar to manufacturer storage
market options.
Order Difficult but essential.
  Retailer store
Pickup site

Customers

Information flow
Customer flow

RETAILER STORAGE WITH

CUSTOMER PICKUP
Cost Factor Performance
Inventory Higher than all other options.
Transportation Lower than all other options.
Facilities and Higher than other options. The
handling increase in 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.
Service Performance
Factor
Response Same-day (immediate) pickup possible
time for items stored locally at pickup site.
Product Lower than all other options.
variety
Product More expensive to provide than all
availability other options.
Customer Related to whether shopping is viewed
experience as a positive or negative experience by
customer.
Time to Highest among distribution options.
market
Order Trivial for in-store orders. Difficult, but
visibility essential, for online and phone orders.
Returnability Easier than other options because retail
 4. SELECTING A
DISTRIBUTION
NETWORK DESIGN
COMPARATIVE PERFORMANCE OF
DELIVERY NETWORK DESIGNS
 DELIVERY NETWORK FOR DIFFERENT
PRODUCTS/CUSTOMER CHARACTERISTICS
 CENTRALIZED VS. DECENTRALIZED
NETWORK DESIGNS (1 OF 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
 EXAMPLE 1

Manufacturer
Demand Probabilist
ic
8,000 11%
DC (owned 10,000 11%
by
12,000 28%
retailers)
14,000 22%
16,000 18%
Retailers 18,000 10%

Customer demand
Centralized system Decentralized system
 EXAMPLE 1 (CONT.)

Each Manufactur
Strategy System
retailer er
$2,170,53
Centralized $500,268 $1,170,000
6
Decentraliz $2,021,40
$470,700 $1,080,000
ed 0
Since both each retailer and manufacturer earns
more profits in the centralized system, both prefer
the centralized system over decentralized one.
 CENTRALIZED VS. DECENTRALIZED
NETWORK DESIGNS (2 OF 4)

• 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.
• What if the customer search within the system for
alternatives? Can the retailers take advantage of
the search process? Does it affect the preference
over centralized/ decentralized system?
• This question can be only addressed using concepts
from game theory, and in particular Nash
equilibria.
 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.
• 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 quant. if the other doesn’t
 EXAMPLE 2 (1 OF 3)

 Let’s return to our example. We let represent the

percentage of customers that search the system. In
the other words, the percentage of customers who
check the other retailer if their demand is not met at
the first retailer. Using this information, each retailer
can determine what its effective demand will be (that
is, what its initial demand and the searched demand
will total) if the other retailer order a specific amount.
Based on this information, they can calculate how
much they should order given any order by their
competitors. This is known as their best response.
The following graph depicts the retailers’ best
response given , so that 90% of the customers whose
 EXAMPLE 2 (2 OF 3)

• As retailer 1 would increases its inventory (pink

curve), retailer 2’s inventory decreases, up to a
certain amount
 EXAMPLE 2 (3 OF 3)

• The two retailers has no incentive to modify its

strategy is when they order the amount of 13,900
each, associated with the intersection of the two
curves. This is the unique Nash equilibrium for
this system.
Each Manufactur
Strategy System
retailer er
$2,179,39
Centralized $504,696 $1,170,000
2
Decentraliz $2,229,92
The $489,460 $1,251,000
ed centralized system doesn’t strictly dominate
0
the decentralized one. While the retailer prefers the
centralized system, the manufacturer prefers the
decentralized one.
 CENTRALIZED VS. DECENTRALIZED
NETWORK DESIGNS (3 OF 4)

Amount ordered by retailers as a function of the search level

 CENTRALIZED VS. DECENTRALIZED
NETWORK DESIGNS (4 OF 4)

 
As increases
• Each retailer’s order quantity and profit increases.
• Retailers’ total expected profit will be higher in the
centralized pooling system than in the
decentralized system  Retailers prefer a
centralized system
• In the decentralized system, the retailers tend to
order more than in a centralized one, increasing the
manufacturer’s profit  the manufacturer will
prefer a decentralized system.
• Critical search level: When customer search is
below that level, the manufacturer prefers the
 REFERENCE

1. Simchi-Levi, D., Kaminisky, P, Simchi-Levi, E. Designing and

managing the supply chain: Concepts, strategies, and cases
studies, 3rd ed., Chapter 7. McGraw-Hill Education: 2007.

2. Chopra, S., Meindl, P. Supply chain management: Strategy,

Planning and Operation, 6th ed., Chapter 4. Pearson: 2015.