NETWORK DESIGN IN

SUPPLY CHAIN
 Outlines
 Network Design Decisions
 Factors Influencing Network Design Decisions
 A Strategic Framework For Facility Location
 Gravity Models For Location
 Network Optimization Models
 Plant Location Models
 Locating Plants And Ware Houses Simultaneously
 Network Design Decisions
• Facility role: What role should each facility play? What
processes should be performed at each facility?

• Facility location: Where should facilities be located?

• Capacity allocation: How much capacity should be allocated

to each facility?

• Market and supply allocation: What markets should each

facility serve? Which supply sources should feed each facility?

• (How many plants, DC’s, retail stores, etc. to build?)

 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
 Phase I: Strategy Considerations
• Understand where is the main emphasis:
– Cost leadership
– Responsiveness
– Product differentiation
• Who are the key competitors at each target market?
• Identify constraints on available capital
• Key mechanisms that will support growth
– Reuse of existing facilities
– Build new facilities
– Partner with other companies (mergers and acquisitions are potential
options here)
 Service and Number of Facilities
Response
Time

Number of Facilities
Costs and Number of Facilities

Inventory

Costs Facility costs

Transportation

Number of facilities
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
 Phase II: Regional facility
configuration
• Important Factors:
• Regional demand
• Production technologies and economies of scale
and scope
• Tariffs and Tax incentives
• Infrastructure factors
• Political, exchange rate and demand risk
• Competitive Environment
 Regional demand
• Forecast the demand on a region by region basis
• Need to study its
– size
– homogeneity
• Non-homogeneous demand will require a more localized
network
• Frequently the final customization of a product for a particular
market is done at a local distribution center
– Labeling
– Manuals etc.
 Production technologies and the
underlying economies
• Expensive dedicated production technologies will require large
production volumes and therefore a more centralized production
network (e.g., chip production).
• Lower fixed cost facilities can be duplicated more easily (e.g.,
bottling factories).
• In case of non-homogeneous demand, technological flexibility
facilitates consolidation of production to a few manufacturing
facilities.
• The more cumbersome the transfer of raw material, the closer the
facility must be to the source site (e.g., factories processing
minerals)
 Tariffs and Tax incentives
• Tariffs: Any duties that must be paid when products and/or equipment are moved
across international, state or city boundaries.
• High tariffs necessitate localized production.
• Presently, there is a systematic effort to open the markets to global competition
through the World Trade Organization Policies (WTO) and regional agreements
(NAFTA, MERCOSUR for S. America, ASEAN for Pacific rim, etc.)
• Tax incentives: a reduction in tariffs or taxes that countries, states and cities often
provide to encourage firms to locate their facilities in specific areas.
• Free trade zones: Areas where duties and tariffs are relaxed as long as production is
used primarily for export (e.g., Taiwan and China’s GuangZhou area) Allows
companies to take better advantage of low labor costs.
• Tax incentives can be focusing on certain
– Industries
– Technologies
– Regions
• Quotas: Limits on import volumes placed by different countries in an effort to
protect their local industry. Sometimes there is also some requirement on minimum
local content.
 Infrastructure factors
• Availability of skilled labor
• Availability of transportation facilities
– Ports
– Airports
– Rail
– Highways
• Availability of necessary utilities
– Power
– Water
– Sewage
– Telecommunications / IT
 Political, exchange rate and demand
Risks
• Political risks -- Need for:
– Well-defined rules of commerce
– Independent and clear legal systems
– Political stability
• Exchange rate risks: This risk arises from the fact that companies might incur
their costs in one currency and collect their revenues in other currencies.
(e.g., Japanese production under an expensive Yen in the late 80’s / early
90’s; the role of an expensive EURO these days for the American economy)
• Potential protection to exchange rate risk: Build some flexible over-capacity
to the regional facilities so that production is shifted to the lower-cost
regions.
• Demand risk: Comes from extensive demand fluctuation due to regional
economic crises (e.g., Asia markets between 1996-1998) Plant flexibility is
also a potential protection to this type of risk.
 Competitive factors
• Positive Externalities: Instances where collocation of multiple firms benefits
all of them, since
– They share the cost of the necessary infrastructure
– And the collocation can stimulate demand for all of them
– Examples: a mall, silicon valley, industrial parks
• Locating to “split the market”: For companies that
– Do not have price control, and
– try to maximize their market share by minimizing their distance from the customer,
collocation can allow each competing party to maximize their market share.

a b

Total demand = 1

D1 = a + (1-b-a)/2 = (1+a-b)/2 a = b = 1/2

D2 = 1-a-(1-b-a)/2 = (1+b-a)/2 =>
 Phases III & IV: Selecting specific
locations
• Important factors
• Infrastructure
• Costs
– Labor
– Materials
– Facilities
– Transport
– Inventory
– Taxes and Tariffs
 Models For Facility Location And Capacity
Allocation
Main goal is to “ maximize profitability of the resulting supply
chain network”.
The following information must be available before design
decision can be made.

 Location of supply source and markets.

 Location of potential facility sites.
 Demand forecast by market.
 Facility,labour,and material costs by site
 Transportation costs between each pair of sites.
 Inventory costs by site as well as a function of quantity.
 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?

 Stages in supply network
Suppliers Plants Ware houses Markets
 THE CAPACITED PLANT LOCATION
MODEL
• The capacitated plant location model requires the following
inputs:
n=Number of potential plant locations/capacity
m=Number of markets or demand points
Dj=Annual demand from market j.
Ki=Potential capacity of plant i.
fi=Annualized fixed cost of keeping factory i open.
cij=Cost of producing and shipping one unit from factory i to
market j.
n n m

Min  f y   c
i 1
i i
i 1 j 1
ij xij
 Sub to
n

x
i 1
ij  D j for j  1,........., m (5.1)
m

x
j 1
ij  K i yi for i  1,......, n (5.2)

y i  {0,1} for i  1,........, n (5.3)

• The objective function minimizes the total

cost(fixed+variable) of settingup and operating the
network.
• The constraint (5.2) states that no plant can supply
more than its capacity.
• This model is solved by using solver tool in exel
Inputs-costs,capacities,demands

demand region production and transportation cost per 1,000,000 units low fixed High

supplyregion N.America S.America Europe Asia Africa cost capacity cost Capacity
N.America 81 92 101 130 115 6000 10 9000 20
S.America 117 77 108 98 100 6000 10 6750 20
Europe 102 105 95 119 111 6500 10 9750 20
Asia 115 125 90 59 74 4100 10 6150 20
Africa 142 100 103 105 71 4000 10 6100 20
Demand 12 8 14 16 7

Decision variables
Demand region-Production Allocation(1000 units) Plants Plants
Supply region N.America S.America Europe Asia Africa (1=open) (1=open)
N.america 0 0 0 0 0 0 0
S.America 0 0 0 0 0 0 0
Europe 0 0 0 0 0 0 0
Asia 0 0 0 0 0 0 0
Africa 0 0 0 0 0 0 0

Constraints
Supply region Excess capacity
N.America 0
S.America 0
Europe 0
Asia 0
Africa 0
N.America S.america Europe Asia Africa
Unmet demand 12 8 14 16 7

Objective function
cost= $
cell Cell formula Equation Copied to

B28 =B9-SUM(B14:B18) 5.1 B28:F28

B22 =G14*H4+H14*J4-SUM(B14:F14) 5.2 B22:B26

B31 =SUMPRODUCT(B14:F18,B4:F8)+ Objective

SUMPRODUCT(G14:G18,G4:G8)+ Function
SUMPRODUCT(H14:H18,14:18)
 GRAVITY MODELS FOR LOCATION

 To find out locations that minimize the cost of

transporting raw materials.
 Assume that both markets and supply sources
can be located as grid points on the same plane.
 These models assume that the transportation cost
grows linearly with the quantity shipped.
 Graphical location models can be useful when
identifying suitable geographical locations with
in the region
 Gravity Models for Location
• Ton Mile-Center Solution
– x,y: Warehouse
Coordinates(locations) 2
( x  x n)  ( y  y n)
2
d 
– xn, yn : Coordinates of delivery n

x
 Dn F d
k
n
location n(market or supply
n

n 1
x n

source) F
 Dn d
k
n

n 1 n

– dn : Distance to delivery y
 Dn F d
k
n n

location n y n 1

F
n

 Dn d
k
n

– Fn cost of shipping one n 1 n

unit.
Min  d n Dn F n
Cost=$3277110
(x,y)=(681,881)
 Demand Allocation Model
• Which market is served
by which plant? n m
Min cij xij
• Which supply sources i 1 j 1

s.t.
are used by a plant? n

x ij
 D j , j  1,..., m
xij = Quantity shipped from i 1
m

x  K , i  1,..., n
plant site i to customer j j 1
ij i

x ij
0
n= Number of factory locations
m=Number of markets or demands points
Dj=Annual demand from market j
Ki=Annual capacity of factory i

c Cost of producing and shipping one unit from factory i to market j

ij =

xij =Quantity shipped from factory i to market j each year

Plant Location with Single Sourcing
• yi = 1 if plant is located n n m

at site i, 0 otherwise
Min f y   D j c x
i i ij ij
i 1 i 1 j 1

• xij = 1 if market j is s.t.

n
supplied by factory i, 0 x ij
 1, j  1,..., m
otherwise i 1
n

 D j x  K y , i  1,..., n
j 1
ij i i

xij , y {0,1}i
 Locating Plants And Warehouses
Simultaneously
 In this we consider a supply chain in which suppliers send
material to factories that supply warehouses.
 Location and capacity allocation decisions have to be made for
both factories and warehouses .
 Multiple warehouses may be used to satisfy the demand at a
market.
 It is also assumed that units have been appropriately adjusted
such that one unit of input from a supply source produces one
unit of finished product.
 n t l n n t t m

Min  f i yi   f e ye    cni xni    cie xie    cej xej

i 1 e 1 n 1 i 1 i 1 e 1 e 1 j 1

• m=Number of markets o demand points

• n=Number of potential factory locations
• l =Number of suppliers
• t=Number of potential ware house locations
• Dj=Annual demand from customer j.
• Ki=Potential annual capacity of factory at site i
• Sh=Annual capacity at supplier h.
• We=Potential annual warehouse capacity at site e.
• Fi=Fixed annual cost of locating a plant at site i.
• fe= Fixed annual cost of locating a warehouse at site e.