5 Network Design in the

Supply Chain

EMGT 5631
Supply Chain Management
 Important Notes
The information that appears in many of these
slides is based on support materials that
accompany the primary text for this course:
• Supply Chain Management: Strategy, Planning,
and Operation ( 6th and 7th ed.)
• Sources for other information are cited where
appropriate.

5–2
 The Role of Network Design
• Facility role
– What role, what processes? (decides flexibility)
– e.g. Toyota case, a localized plant for local market before 1997;
• Facility location
– Where should facilities be located?
• Capacity allocation
– How much capacity at each facility?
• Market and supply allocation
– What markets? Which supply sources?
• Revisit design decisions after market changes, mergers, or factor
cost changes

5–3
 Factors Influencing
Network Design Decisions

• Strategic factors (e.g, cost leadership? Responsiveness?)

• Technological factors
• Macroeconomic factors
– Tariffs and tax incentives
– Exchange-rate and demand risk
– Freight and fuel costs
• Political
• Infrastructure factors
• Competitive factors
– Positive externalities between firms (collocation of multiple firms benefit all of
them; e.g., all retails are at the same mall)
– Locating to split the market (when there is no positive externalities)
• Customer response time and local presence
• Logistics and facility costs
5–4
 Competitive Factors (more detailed)

– Positive externalities between firms

• Collocation benefits all FIGURE 5-1

Customer demands is evenly distributed between 0 and 1

– Locating to split the market

• Locate to capture largest market share

Demand of the 1– b – a 1+ b – a
d
first company 1
=a + and d 2 = = 1- (1-b-1)/2
2 2
Demand of the
second
company 5–5
Framework for Network Design Decisions
FIGURE 5-2

5–6
 Framework for Network Design Decisions
• Phase I: Define a Supply Chain Strategy/Design
– Clear definition of the firm’s competitive strategy
– Forecast the likely evolution of global competition
– Identify constraints on available capital
– Determine broad supply strategy
• Phase II: Define the Regional Facility Configuration
– Forecast of the demand by country or region
– Economies of scale or scope
– Identify demand risk, exchange-rate risk, political risk, tariffs, requirements
for local production, tax incentives, and export or import restrictions
– Identify competitors
• Phase III: Select a Set of Desirable Potential Sites
– Hard infrastructure requirements
– Soft infrastructure requirements
• Phase IV: Location Choices
5–7
 Models for Facility Location and Capacity
Allocation

• Maximize the overall profitability of the supply

chain network while providing customers with
the appropriate responsiveness
• Many trade-offs during network design
• Network design models used
– to decide on locations and capacities
– to assign current demand to facilities and identify
transportation lanes

5–8
 Models for Facility Location and
Capacity Allocation
• Important information
– Location of supply sources and markets
– Location of potential facility sites
– Demand forecast by market
– Facility, labor, and material costs by site
– Transportation costs between each pair of sites
– Inventory costs by site and as a function of quantity
– Sale price of product in different regions
– Taxes and tariffs
– Desired response time and other service factors

5–9
 Phase II: Network Optimization Model
Capacitated Plant Location Model
n = number of potential plant locations/capacity
m = number of markets or demand points yi= 1 if plant i is open, 0 otherwise
D j = annual demand from market j xij = quantity shipped from plant i
Ki = potential capacity of plant i to market j

f i = annualized fixed cost of keeping plant i open

cij = cost of producing and shipping one unit from plant i to market j (cost includes
Variable
production, inventory, transportation, and tariffs)
cost(production
n n m and shipping)
Fixed cost
Minå f i yi + å åc x ij ij
i=1 i=1 j=1

subject to Demand
satisfaction at
n
all markets
See the attached Excel åx ij
=D j for j =1,...,m
i=1
file (“Figure 5-3 to 5- m Supply can not be
7_SunilOel åx ij
=K i yi for i =1,...,n
more than
capacity, K, when
Example.XLS” j=1 the plan is open y;
if plant is not open
yi Î { 0,1} for i =1,...,n, x ij ³ 0 (y = 0), no shipping
5 – 10
 SunOil Example
• The vice president of supply chain is considering several options
to meet demand.
• One possibility is to set up a facility in each region.
– The advantage is that it lowers transportation cost and helps
avoid duties that may be imposed if product is imported from
other regions.
– The disadvantage is that plants are sized to meet local
demand and may not fully exploit economies of scale.
• An alternative approach is to consolidate plants in just a few
regions.
– This improves economies of scale but increases transportation
cost and duties.
• When designing a regional configuration, the manager must
consider these quantifiable trade-offs along with non-
quantifiable factors such as the competitive environment and
political risk.
5 – 11
Capacitated Plant Location Model (SunOil Example: Figure 5.3 to Figure 5.7)

Capacity Supply Side (i) Market (j) Demand

(low, high)
North North 12 M
(10 M,20 M) America America
Xij = Quantity = ?

South Xij = Quantity South 8M

(10 M,20 M)
America America

(10 M,20 M) Xij = Quantity

Europe Europe 14 M

(10 M,20 M) ….. Asia 16 M

Asia

Xij = Quantity
(10 M,20 M) Africa Africa 7M

5 – 12
Capacitated Plant Location Model (SunOil)
Data Below

FIGURE 5-4

5 – 13
Capacitated Plant Location Model
(SunOil Spreadsheet Model)

FIGURE 5-5

See the attached Excel file (“Figure 5-3 to 5-7_SunOil Example.XLS”) 5 – 14

Capacitated Plant Location Model
(Let us add Solver model)

FIGURE 5-5

5 – 15
 Capacitated Plant Location Model
• Constraints Capacity
constraint

Demand
constraint

5 – 16
Capacitated Plant Location Model

FIGURE 5-6

5 – 17
Capacitated Plant Location Model

20-(10+7) = 3

FIGURE 5-7

5 – 18
 Solution Map
Supply Region Demand Region

N. America N. America Demand: 12

12
8
High Capacity 20 S. America S. America Demand: 8

Europe Europe Demand: 14

4

High Capacity 20 16 Asia Demand: 16

Asia

10
7
High Capacity 20 Africa Africa Demand: 7

Excess capacity
= 20-(10+7) = 3 • No localized plant!
• Instead, consolidating plants is better!
5 – 19
 In Class Exercise
• Q1. Let’s assume that we decide to locate a
plant in Europe for strategic region, but we do
not know its capacity yet (either low or high).
Solve the problem.

• Q2. What if a plant must be built at every

region?

5 – 20
 Phase III: Gravity Location Models
• Having obtained a regional configuration, a manager next identifies potential
locations in each region where the company has decided to locate a plant.
• The manager needs to identify the geographic location where potential sites
may be considered.
• Gravity models are used to find locations that minimize the cost of transporting
raw materials from suppliers and finished goods to the markets served.

xn, yn: coordinate location of either a market or supply

source n
Fn: cost of shipping one unit for one mile between the facility
and either market or supply source n
Dn: quantity to be shipped between facility and market or
(x, y) is the location selected
supply source n for the facility, the distance dn between the
facility at location (x, y) and the supply source or market n is given by

2 2
dn = ( x – x ) +( y – y )
n n

5 – 21
 Steel Appliances (SA) Example
• Steel Appliances (SA), a manufacturer of high-quality refrigerators
and cooking ranges.
• SA has one assembly factory located near Denver, from which it
has supplied the entire United States. Demand has grown rapidly
and the CEO of SA has decided to set up another factory to serve
its eastern markets.
• The supply chain manager is asked to find a suitable location for
the new factory.
• Three parts plants, located in Buffalo, Memphis, and St. Louis,
will supply parts to the new factory, which will serve markets in
Atlanta, Boston, Jacksonville, Philadelphia, and New York.
• The coordinate location, the demand in each market, the
required supply from each parts plant, and the shipping cost for
each supply source or market are shown

5 – 22
 Gravity Location Model
Where is the location of the new factory? (x, y) = ?
Coordinates
Transportation Quantity in
Sources/Markets Cost $/Ton Mile (Fn) Tons (Dn) xn yn
Supply sources
Buffalo 0.90 500 700 1,200
Memphis 0.95 300 250 600
St. Louis 0.85 700 225 825
Markets
Atlanta 1.50 225 600 500
Boston 1.50 150 1,050 1,200
Jacksonville 1.50 250 800 300
Philadelphia 1.50 175 925 975
New York 1.50 300 1,000 1,080
k TABLE 5-1
Total transportation cost TC = ådDF n n n
n=1

5 – 23
Gravity Location Model

FIGURE 5-8
5 – 24
Gravity Location Model

FIGURE 5-8

5 – 25
 Gravity Location Model
1. For each supply source or market n, evaluate dn
2. Obtain a new location (x’, y’) for the facility, where

k k
Dn Fn xn Dn Fn yn
å d å d
n=1 n=1
x ¢= k
n
and y¢= k
n

Dn Fn Dn Fn
å d å d
n=1 n n=1 n

3. If the new location (x’ , y’ ) is almost the same as

(x, y) stop. Otherwise, set (x, y) = (x’ , y’ ) and go to step 1

5 – 26
Phase IV: Network Optimization Models
• Models for Demand Allocation to existing Plant Location
• Given the potential sites that have been identified, a manager must decide on the
location and capacity allocation for each facility.
• Besides locating the facilities, a manager also decides how demand from each market is
to be allocated to facilities. This allocation must account for customer service
constraints in terms of response time. The demand allocation decision can be altered
on a regular basis as costs change and markets evolve. When designing the network,
both location and allocation decisions are made jointly.

• We illustrate the relevant network optimization models using the example of

TelecomOne and HighOptic, two manufacturers of telecommunication
equipment.
• TelecomOne has focused on the eastern half of the United States. It has
manufacturing plants located in Baltimore, Memphis, and Wichita and serves
markets in Atlanta, Boston, and Chicago.
• HighOptic has targeted the western half of the United States and serves
markets in Denver, Omaha, and Portland from plants located in Cheyenne and
Salt Lake City. TABLE 5-2

5 – 27
 Capacity, Demand, and Cost data for
TelecomOne and HighOptic
Demand City
Production and Transportation
Cost per Thousand Units (Thousand $)
Monthly Monthly
Capacity Fixed Cost
(Thousand (Thousand
Supply City Atlanta Boston Chicago Denver Omaha Portland Units) K $) f
Baltimore 1,675 400 985 1,630 1,160 2,800 18 7,650
Cheyenne 1,460 1,940 970 100 495 1,200 24 3,500
Salt Lake 1,925 2,400 1,450 500 950 800 27 5,000
City
Memphis 380 1,355 543 1,045 665 2,321 22 4,100
Wichita 922 1,646 700 508 311 1,797 31 2,200
Monthly 10 8 14 6 7 11
demand
(thousand
units) Dj

5 – 28
 Network Optimization Models
• Allocating demand to production facilities
n = number of factory locations
m = number of markets or demand points xij = quantity shipped from
D j = annual demand from market j factory i to market j
Ki = capacity of factory i
cij = cost of producing and shipping one unit from factory i to market j

n m subject to
Minå å cij xij
n
i=1 j=1 åx =D j for j =1,..., m
ij
i=1
m

åx ij £K i for i =1,..., n
j=1

5 – 29
 Network Optimization Models
• Scenario (1) Optimal demand allocation
– Solve two problems separately, one for HighOptic and the other for
TelecomeOne since there is no overlap between two companies in terms of the
market

Atlanta Boston Chicago Denver Omaha Portland

TelecomOne Baltimore 0 8 2

Memphis 10 0 12

Wichita 0 0 0

HighOptic Salt Lake 0 0 11

Cheyenne 6 7 0

TABLE 5-3

• Five plants (3 from TelecomOne and 2 from HighOptic)

• See “Table 5-3 HighOptic” and “Table 5-3 TelecomeOne” worksheets
in “Figure 5-9 to 5-12_revsed.xls”
5 – 30
 Capacitated Plant Location Model
• Scenario (2) Two companies are merged into a single entity called TelecomOptic
– Merge the companies
– Does all five plants needed to serve all six markets?
– We want to know which plants need to be kept and which ones are shut down.
– Solve using location-specific costs

yi = 1 if factory i is open, 0 otherwise

xij = quantity shipped from factory i to market j
n n m
Minå f i yi + å åc x ij ij
i=1 i=1 j=1

5 – 31
Capacitated Plant Location Model

FIGURE 5-9

5 – 32
Capacitated Plant Location Model

FIGURE 5-10
5 – 33
Capacitated Plant Location Model

FIGURE 5-10

5 – 34
 Capacitated Plant Location Model

• See “Figure 12” worksheets

FIGURE 5-11
in “Figure 5-3 to 5-7_revsed.xls” 5 – 35
Capacitated Plant Location Model

• Only three plants

needed!
• Some markets are
supplied by
multiple Suppliers
(e.g. Chicago by
Baltimore and
Memphis)

• See “Figure 12” worksheets FIGURE 5-12

in “Figure 5-9 to 5-12_revsed.xls” 5 – 36
 Capacitated Model With
Single Sourcing

• (scenario 3) One market supplied by only one factory

• Modify decision variables
yi = 1 if factory i is open, 0 otherwise
xij = 1 if market j is supplied by factory i, 0 otherwise
n n m
Minå f i yi + å å D j cij xij
i=1 i=1 j=1 Only one factory i is
subject to assigned to market j

åx ij =1 for j =1,..., m
•
i=1 Factory i should
m
be open (yii=1) to
å Dx j ij £K i yi for i =1,..., n
serve market j
j=1

xij , yi Î { 0,1} under its total

capacity

5 – 37
 Capacitated Model With
Single Sourcing
• Optimal network configuration with single
sourcing
Open/
Closed Atlanta Boston Chicago Denver Omaha Portland
Baltimore Closed 0 0 0 0 0 0
Cheyenne Closed 0 0 0 0 0 0
Salt Lake Open 0 0 0 6 0 11

Memphis Open 10 8 0 0 0 0
Wichita Open 0 0 14 0 7 0

TABLE 5-4

• See “Table 5-4 Single Sourcing” worksheets

in “Figure 5-9 to 5-12_revsed.xls”
5 – 38
Locating Plants and Warehouses
Simultaneously

FIGURE 5-13

5 – 39
 Locating Plants and Warehouses
Simultaneously
• Model inputs
m = number of markets or demand points
n = number of potential factory locations
l = number of suppliers
t = number of potential warehouse locations
Dj = annual demand from customer j
Ki = potential capacity of factory at site i
Sh = supply capacity at supplier h
We = potential warehouse capacity at site e
Fi = fixed cost of locating a plant at site i
fe = fixed cost of locating a warehouse at site e
chi = cost of shipping one unit from supply source h to factory i
cie = cost of producing and shipping one unit from factory i to
warehouse e
cej = cost of shipping one unit from warehouse e to customer j
5 – 40
 Locating Plants and Warehouses
Simultaneously
• Goal is to identify plant and warehouse locations and
quantities shipped that minimize the total fixed and
variable costs

yi = 1 if factory is located at site i, 0 otherwise

ye = 1 if warehouse is located at site e, 0 otherwise
xej = quantity shipped from warehouse e to market j
xie = quantity shipped from factory at site i to
warehouse e
xhi = quantity shipped from supplier h to factory at site
i n t l n
Minå F y + å f y + å å c x + å å c x +å å c x
hi
n t t m

i i e e hi ie ie ej ej
i=1 e=1 h=1 i=1 i=1 e=1 e=1 j=1

5 – 41
 Locating Plants and Warehouses
Simultaneously What does
this
constraint
subject to mean?

n m

åx hi
£Sh for h =1,...,l åx ej
£We ye for e =1,...,t
i=1 j=1
l t t

åx hi
– å xie ³ 0 for i =1,...,n åx ej
=D j for j =1,...,m
h=1 e=1 e=1
t

åx ie
£ K i yi for i =1,...,n yi , ye Î { 0,1} , xej , xie , xhi ³ 0
e=1
n m

å x –å x
ie ej
³ 0 for e =1,...,t What does
this
i=1 j=1
constraint
mean?

5 – 42
 Accounting for Taxes, Tariffs, and
Customer Requirements
• A supply chain network should maximize profits after
tariffs and taxes while meeting customer service
requirements
• Modified objective and constraint

m n n n m
Maxå rj å xij – å Fi yi – å å cij xij
j=1 i=1 i=1 i=1 j=1
n

åx ij
£D j for j =1,...,m
i=1

5 – 43
Making Network Design Decisions
In Practice
• Do not underestimate the life span of
facilities
• Do not gloss over the cultural implications
• Do not ignore quality-of-life issues
• Focus on tariffs and tax incentives when
locating facilities

5 – 44
Summary of Learning Objectives
1. Understand the role of network design in
a supply chain
2. Identify factors influencing supply chain
network design decisions
3. Develop a framework for making network
design decisions
4. Use optimization for facility location and
capacity allocation decisions

5 – 45