Supply Chain Management

(2nd Edition)
Chapter 5
Network Design in the Supply
Chain

© 2004 Prentice-Hall, Inc. 5-1

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

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 Network Design Decisions
 Facility role
 Facility location
Ex: Toyota, Amazon.com
 Capacity allocation
 Market and supply allocation

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 Factors Influencing
Network Design Decisions
 Strategic Factors
 Technological
 Macroeconomic
 Political
 Infrastructure
 Competitive
 Customer Response Time and Local presence
 Logistics and facility costs

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 Strategic Roles of a Facility
 Offshore facility: Low cost facility for export
production
 Source Facility: Low cost facility for global
production
 Server Facility: Regional Production Facility
 Contributor Facility: Regional Production Facility
with Development Skills
 Outpost Facility: Regional Production Facility built to
gain local skills
 Lead Facility: Facility that leads in development and
process technologies

© 2004 Prentice-Hall, Inc.

 Technological Factors
 Characteristics of available production technologies
have a significant impact on the network design:
– If production technology provide significant economies of
scale, few high capacity locations are the most effective
– If facilities have lower fixed costs, many local facilities are
preferred.
 Flexibility of the production technology impacts the
degree of consolidation in the network:
– If the production technology is inflexible, build many local
facilities
– Else, build few but large facilities

© 2004 Prentice-Hall, Inc.

 Macroeconomic Factors
 Tariffs and tax incentives
– Tariffs: Any duties that must be paid when product,
equipment are moved across an international, state
or city boundry.
– Developing countries have free trade zones
 Exchange rate and demand risk
– Valuable TRL and textile industry in Turkey

© 2004 Prentice-Hall, Inc.

 Infrastructure Factors
 Availability of sites
 Availability of labor
 Proximity to transportation terminals,
railservice, airports, seaports,
 Highway access
 Congestion
 Local utilities

© 2004 Prentice-Hall, Inc.

 Competitive Factors
 Positive externalities between firms
– Ex: Gas stations and retail shops
Auto Repair Districts
 Locating to Split the market
– When firms do not control price, but compete on
distance from the customer, they can maximize
market share by locating close to each other and
splitting the market

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 Ex:Locating to Split the Market
 Let there be two firms located at
points a and 1-b on a line segment
between 0 and 1. Let the
customers be located uniformly on 0 a 1-b 1
this line. a 1 b
If the total demand is 1, the 2
demand at the two firms is
maximized when a=b=1/2. a 1 b 1 b  a
d1  , d2 
2 2
Thus the market share is
maximized when both firms are
together, although the average
distance travelled is greater than
the seperate case.

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 Service and Number of Facilities
Response
Time

Number of Facilities

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Where inventory needs to be for a one week order
response time - typical results --> 1 DC

Customer
DC

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Where inventory needs to be for a 5 day order
response time - typical results --> 2 DCs

Customer
DC

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Where inventory needs to be for a 3 day order
response time - typical results --> 5 DCs

Customer
DC

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Where inventory needs to be for a next day order
response time - typical results --> 13 DCs

Customer
DC

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Where inventory needs to be for a same day / next
day order response time - typical results --> 26 DCs

Customer
DC

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 Costs and Number of Facilities

Inventory

Costs Facility costs

Transportation

Number of facilities

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 Cost Buildup as a Function of Facilities
Total Costs
Cost of Operations

Percent Service
Level Within
Promised Time
Facilities
Inventory
Transportation
Labor

Number of Facilities
© 2004 Prentice-Hall, Inc. 5-18
 A Framework for
Global Site Location
Competitive STRATEGY GLOBAL COMPETITION
PHASE I
Supply Chain
INTERNAL CONSTRAINTS Strategy
Capital, growth strategy, TARIFFS AND TAX
existing network INCENTIVES

PRODUCTION TECHNOLOGIES REGIONAL DEMAND

Cost, Scale/Scope impact, support PHASE II Size, growth, homogeneity,
required, flexibility
Regional Facility local specifications
Configuration
COMPETITIVE
ENVIRONMENT POLITICAL, EXCHANGE
RATE AND DEMAND RISK

PHASE III
Desirable Sites AVAILABLE
INFRASTRUCTURE
PRODUCTION METHODS
Skill needs, response time

FACTOR COSTS PHASE IV LOGISTICS COSTS

Labor, materials, site specific Location Choices Transport, inventory, coordination

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 A Framework For Network Design
Decisions
 Define SC Strategy
– Base the strategy on the competitive strategy, economies of
scale or scope.
 Define the regional facility configuration
– Approx. no. of facilities, regions where facilities will be set
up, whether a facility will produce all products of a given
market, etc
 Select desirable sites within a given region
– Based on the analysis of infrastructure availability
 Location choices
– Select a precise location and capacity allocation for each
facility

© 2004 Prentice-Hall, Inc.

 Conventional Network

Materials Customer
Vendor Finished Customer
DC Store
DC Goods DC DC

Customer
Component Store
Vendor Manufacturing
DC Plant Customer Customer
Warehouse DC Store
Components
DC Customer
Vendor Store
DC Finished
Customer
Goods DC
Final DC Customer
Assembly Store

© 2004 Prentice-Hall, Inc. 5-21

 Tailored Network: Multi-Echelon
Finished Goods Network
Local DC
Cross-Dock Store 1
Regional Customer 1
Finished DC
Goods DC Store 1
Local DC
Cross-Dock
National Store 2
Customer 2
Finished
DC
Goods DC
Local DC Store 2
Cross-Dock
Regional
Finished Store 3
Goods DC

Store 3

© 2004 Prentice-Hall, Inc. 5-22

 Models for Facility Location and
Capacity Allocation
 Goal is to maximize the overall profitability while
providing the appropriate responsiveness.
 Managers use network design models in two different
ways:
– Decide on locations and capacities of facilities
– Decide on the market share of each facility and identify
lanes of transportation
 Models are two types:
– Network optimization models
– Gravity models

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 The Required Inputs for the Models
 Location of suppliers
 Location of potential facility sites
 Demand forecast by market
 Facility, labor, material costs
 Transportation costs between sites
 Inventory costs by site and unit
 Sale prices in different regions
 Taxes and tariffs between locations
 Desired response time and other service measures
© 2004 Prentice-Hall, Inc.
 Phase II: Network Optimization Model
The capacitated plant location model
Inputs:
n: # potential plant locations/capacity
m: # markets or demand points
Dj: Annual demand from market j, j=1,2,...,m
Ki: Potential capacity of plant i, i=1,2,...,n
fi: Annualized fixed cost of keeping factory i open
cij: Cost of producing and shipping one unit from factory i to market j.

Decision variables:
Yi: 1 if plant i is open, 0 otherwise
Xij: quantity shipped from factory i to market j

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 The capacitated plant location model (cont’d)

n n m
Min f i yi   cij xij
i 1 i 1 j 1

Subject to
n

x
i 1
ij  Dj , j  1,2,..., m
m

x
j 1
ij  K i yi , i  1,2,..., n

yi  {0,1} i  1,2,..., n

© 2004 Prentice-Hall, Inc.

 Ex: Sun Oil Company
 Vice president of Supply Chain decides to view the worldwide demand
in five regions: North America, South America, Europe, Asia, Africa

Demand Region
  Production and Transportation Cost per 1,000,000 Units Fixed Low Fixed High

Supply Region N. America S. America Europe Asia Africa Cost ($) Capacity Cost ($) Capacity

N. America 81 92 101 130 115 6,000 10 9,000 20

S. America 117 77 108 98 100 4,500 10 6,750 20

Europe 102 105 95 119 111 6,500 10 9,750 20

Asia 115 125 90 59 74 4,100 10 6,150 20

Africa 142 100 103 105 71 4,000 10 6,000 20

Demand 12 8 14 16 7        

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 Gravity Methods for Location
 Ton Mile-Center Solution 2 2
dn  ( x  x n  ( y  y n)
)
– x,y: Warehouse Coordinates
n
– xn, yn : Coordinates of delivery  xi F i
location n i 1 Fi
– dn : Distance to delivery x di
n
location n
 Fi
– Fn : Annual tonnage to delivery i 1 di
location n n yi F i

i 1 Fi
y di
 2 (  y )2
Min F i ( xi  x)  y i n
 Fi
i 1 di
© 2004 Prentice-Hall, Inc. 5-28
 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?

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 Demand Allocation Model
n m
 Which market is served
Min   cij xij
by which plant? i 1 j 1
 Which supply sources s.t.
are used by a plant? n
xij = Quantity shipped from  xij  D j
i 1
plant site i to customer j m
 xij  K i
j 1

xij  0

© 2004 Prentice-Hall, Inc. 5-30

 Plant Location with Multiple Sourcing
 yi = 1 if plant is located n n m
Min  f i y i    cij xij
at site i, 0 otherwise i 1 i 1 j 1
 xij = Quantity shipped s.t.
from plant site i to n
customer j  xij  D j
i 1
n
 xij  K i y i
j 1
m
 y i  k ; y i  {0,1}
i 1

© 2004 Prentice-Hall, Inc. 5-31

 Value of Adding 0.1 Million
Pounds Capacity (1982)
Mexico $0
Canada $8,300
Venezuela $36,900
Frankfurt $22,300
Gary $25,200
Sunchem $0

Should be evaluated as an option and priced accordingly.

© 2004 Prentice-Hall, Inc. 5-32
 Evaluating Facility Investments:
AM Tires

Plant Dedicated Plant Flexible Plant

Fixed Cost Variable Cost Fixed Cost Variable Cost
US 100,000 $1 million/yr. $15 / tire $1.1 million $15 / tire
/ year
Mexico 4 million 110 pesos / 4.4 million 110 pesos /
50,000 pesos / year tire pesos / year tire
U.S. Demand = 100,000; Mexico demand = 50,000
1US$ = 9 pesos

Demand goes up or down by 20 percent with probability 0.5 and

exchange rate goes up or down by 25 per cent with probability 0.5.
© 2004 Prentice-Hall, Inc. 5-33
 AM Tires
Perio d 0 Perio d 1 Perio d 2
RU=14 4
RM = 72
E=1 4.06
RU=12 0
RM = 60 RU=14 4
E=1 1.25 RM = 72
E=8 .4 4
RU=12 0
RM = 60 RU=14 4
E=6.7 5 RM = 48
E=1 4.06
RU=12 0
RM = 40 RU=14 4
E=1 1.25 RM = 48
E=8 .4 4
RU=10 0 RU=12 0
RM=50 RM = 40 RU=96
E=9 E=6.7 5 RM = 72
E=1 4.06
RU=80
RM = 60 RU=96
E=1 1.25 RM = 72
E=8 .4 4
RU=80
RM = 60 RU=96
E=6.7 5 RM = 48
E=1 4.06
RU=80
RM = 40 RU=96
E=1 1.25 RM = 48
E=8 .4 4
RU=80
RM = 40
E=6.7 5

© 2004 Prentice-Hall, Inc. 5-34

 AM Tires
Four possible capacity scenarios:
• Both dedicated
• Both flexible
• U.S. flexible, Mexico dedicated
• U.S. dedicated, Mexico flexible

For each node, solve the demand allocation model.

Plants Markets
U.S. U.S.

Mexico Mexico

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 Facility Decision at AM Tires

Plant Configuration NPV

United States Mexico
Dedicated Dedicated $1,629,319
Flexible Dedicated $1,514,322
Dedicated Flexible $1,722,447
Flexible Flexible $1,529,758

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 Capacity Investment Strategies
 Speculative Strategy
– Single sourcing
 Hedging Strategy
– Match revenue and cost exposure
 Flexible Strategy
– Excess total capacity in multiple plants
– Flexible technologies

© 2004 Prentice-Hall, Inc. 5-37

 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.
 How are the following optimization methods used
for facility location and capacity allocation
decisions?
– Gravity methods for location
– Network optimization models

© 2004 Prentice-Hall, Inc. 5-38