Network Design McGraw-Hill/Irwin Copyright © 2010 by The McGraw-Hill Companies, Inc. All rights reserved.

Network design overview Enterprise facility network Warehouse requirements Systems concept and analysis Total cost integration Formulating logistical strategy

Enterprise facility network Availability of economical transportation provides opportunity for facility networks Design requirements are from integrated procurement, manufacturing and customer accommodation strategies Logistics requirements are satisfied by achieving total cost and service trade-offs

Spectrum of location decisions exists but chapter focus is on selecting warehouse locations Transportation services link locations into an integrated logistical system Selection of individual locations represents competitive and cost-related logistical decisions Manufacturing plant locations may require several years to fully deploy Warehouses can be arranged to be used only during specified times Retail locations are influenced by marketing and competitive conditions

Local presence: an obsolete paradigm Local presence paradigm Transportation services started out erratic with few choices Customers felt that inventory within the local market area was needed to provide consistent delivery Contemporary view Transportation services have expanded Shipment arrival times are dependable and consistent Information technology Provides faster access to customer requirements Enables tracking of transport vehicles

Warehouse requirements Warehouses exist to lower total cost or improve customer service Warehouses specialize in supply or demand facing services Facilities used for inbound materials are supply facing warehouses Facilities used for customer accommodation are demand facing warehouses Functionality and justification are different based on facilities support role Procurement Manufacturing Customer accommodation

Procurement drivers help purchase materials and components at the lowest total inbound cost Limited number of deeper relationships with suppliers Life cycle considerations E.g. material purchase, reclamation, and disposal of unused materials Debundling of value-added services leading to new structural relationships with suppliers Seasonality of selected supplies Opportunities to purchase at reduced prices Rapid accommodation of manufacturing spikes Facilities placing more emphasis on sorting and sequencing materials

Manufacturing drivers help consolidate finished product for outbound customer shipment Provide customers full-line product assortment on a single invoice at truckload transportation rates Choice of manufacturing strategy is primary driver Make to plan (MTP) Requires substantial demand facing warehousing Make to order (MTO) Requires supply facing support, but little demand warehousing Assemble to order (ATO)

Customer accommodation drivers provide custom inventory assortments to wholesalers/retailers Maximize consolidation and length of haul from plants Rapid replenishment from wholesalers E.g. food and mass merchandise industries Market-based ATO situations using decentralized warehouses Size of market served by warehouse based on Number of suppliers Desired service speed Size of average order Cost per unit of local delivery

Warehouse justification is based on providing a service or cost advantage from their location Must achieve freight consolidation with warehouse positioning Inventory storage to support customized orders Mixing facilities to support flow-through and cross-dock sorting

Key design questions to ask when developing a logistics network How many and what kinds of warehouses should a firm establish? Where should they be located? What services should they provide? What inventories should they stock? Which customers should they service?

The “Systems” Concept Systems concept is an analytical framework that seeks total integration of components essential to achieving stated objectives Components of logistical system are its functions Order processing Inventory Transportation Warehousing Materials handling and packaging Facility network design

Systems analysis seeks to quantify trade-offs between logistics functions Goal of system analysis is to create an integrated effort (i.e., a whole) which is greater than its individual parts Goal from a process perspective is balanced performance between functional areas both within the enterprise and across its supply chain Functional excellence is the contribution a function makes to the success of the overall system (or process) Focus of system analysis is on interactions (i.e., relationships) between components

Principles of general systems theory Total system performance is singularly important Individual components don’t need to be optimized Emphasis is on the integrated relationship between components A functional relationship exists between components called a trade-off May enhance or hinder total system performance Components linked together in a balanced system will produce greater end results than possible through individual performance, i.e., synergy!

A systems concept example Customer service is an integral part of total system performance However, Customer service must also be balanced against other components Accommodating the customer to the extent that you put yourself out of business is not serving the customer! There must be a balance between cost and customer service Building relationships with customers is key to this balance i.e., customers become a component of the supply chain system

Total cost integration Initial network of facilities are driven by economic factors Transportation economics Inventory economics Cost trade-offs of these individual functions are identified, but A system analysis approach (i.e. total cost integration) is used to identify the least-total-cost for the combined facility network

Transportation economics Two basic principles for economical transportation Quantity principle is that individual shipments should be as large as the carrier can legally transport in vehicle Tapering principle is that large shipments should be transported distances as long as possible Cost-based warehouse justification Based on transportation consolidation Network transportation cost minimization

Example of cost-based warehouse justification using transportation consolidation Assumptions Average shipment = 500 lbs Freight rate to customer = $7.28 per cwt Volume transport rate = $2.40 per cwt For shipments 20,000+ lbs Local delivery within market = $1.35 per cwt Options Direct ship to customer = $36.40 per average shipment Ship to market at volume rate and distribute locally Total rate = $3.75 per cwt $18.75 per average shipment Can you justify the use of a warehouse in this situation?

Network transportation cost minimization Figure 12.2 Transportation Cost as a Function of the Number of Warehouse Locations

Inventory economics is driven by service response time Performance cycle is key driver Forward deployment of inventory potentially improves service response time, but Increases overall system inventory

Service-based warehouse justification Inventory consists of Base stock Safety stock In-transit stock What is the impact of adding warehouses to each of these inventories? Base stock is independent of number of market facing warehouses What about in-transit stock? Although available to promise, it cannot be physically accessed!

Additional warehouses typically reduce total in-transit inventory Results Figure 12.3 Logistical Network: Two Markets, One Warehouse Figure 12.4 Logistical Network: Two Markets, Two Warehouses Table 12.1 Transit Inventory under Different Logistical Networks

What about the impact on safety stock? Safety stock is needed to protect against unplanned stockouts during inventory replenishment Uncertainty in network is impacted by adding warehouses Performance cycle days are reduced Number of performance cycles increases Prevents aggregation of uncertainty across market areas Serving the same market area by adding warehouses will increase uncertainty since each facility has its own replenishment cycle Therefore, more safety stock is needed

Combining demand into one warehouse averages demand variability Table 12.4 Summary of Sales in One Combined and Three Separate Markets More safety stock is required if markets served from ‘local’ warehouse

Inventory summary Base stock determination is independent of number of market facing warehouses In-transit stock will typically decrease with the addition of warehouses to the network Safety stock increases with number of warehouses added to the network New performance cycle requires additional safety stock

Network inventory cost minimization Figure 12.5 Average Inventory as a Function of Number of Warehouse Locations

Total cost of the network is illustrated in Figure 12.6 Figure 12.6 combines cost curves from Figure 12.2 and 12.5 Lowest cost points on each curve For total transportation cost between 7 and 8 facilities For inventory cost it would be a single warehouse For total cost of network it is 6 locations Trade-off relationships Minimal total cost point for the system is not at the point of least cost for either transportation or inventory

Illustration of total cost concept for the overall logistical system Figure 12.6 Least-Total-Cost Network

Analysis summarized in Figure 12.6 does not include all relevant costs Assumptions are important to understand for their impact on finalizing a strategy Analysis summarized in Figure 12.6 does not include all relevant costs Projected sales based on a single planning period Transportation costs based on a single average-size shipment Desired inventory availability and fill rate assumptions impact the solution

Limitations to accurate total cost analysis Many important costs are not specifically measured or reported Need to consider a wide variety of network design alternatives Alternative shipment sizes Alternative modes of shipment Range of available warehouse locations

Figure 12.x Three-Dimensional Total Cost Curve Visualization of solution adding variables shipment size, transportation mode and location Figure 12.x Three-Dimensional Total Cost Curve

General approach to finalizing a logistical strategy Formulating logistical strategy requires evaluating alternative customer service levels and costs General approach to finalizing a logistical strategy Determine a least-total-cost network Measure service availability and capability for this network Conduct sensitivity analysis for incremental service options Use cost and revenue associated with each option Finalize the plan

Threshold service level is customer service associated with the least-total-cost-system Existing policies of availability and capability are often assumed as the threshold service level Current performance provides starting point for potential service improvements Result of a customer service availability analysis is shown in Figure 12.7 for warehouses X, Y and Z Based on distribution of an average order Delivery time is estimated on the basis of distance Transit inventory estimated based on delivery time Management can make basic customer delivery commitments of the basic service platform Use an estimate of expected order cycle time

Illustration of total logistics cost for three warehouse locations Figure 12.7 Determination of Service Territories: Three-Point, Least-Cost System

Basic service capabilities of a network change with variations in Service sensitivity analysis uses the threshold service level to evaluate potential changes Basic service capabilities of a network change with variations in Number of warehouses Adding warehouses increases fixed costs Performance cycles E.g., web-based ordering, premium transportation Typically increases variable costs Safety stock policy Increase in SS will shift average inventory cost curve upward

Variations in the number of warehouse locations is illustrated in Table 12.5 in the text Key points from this table Incremental service is a diminishing function High degrees of service are achieved much faster for longer performance intervals than for shorter intervals Total cost increases dramatically with each location added to the logistical network Portfolio effect is the relationship between uncertainty and required inventory Portfolio effect can be estimate using the square root rule

Finalizing strategy requires evaluating the incremental service cost vs. incremental revenue Figure 12.8 illustrates an example Marketing proposes 2% improvement in inventory availability 36-hour improvement in delivery capability Design analysis determines a 12 warehouse lowest-cost network is needed Incremental total cost to achieve proposed option = $400k per year Incremental revenue needed to break even = $4million per year Assumes 10% profit margin

Figure 12-8 Comparative Total Cost for 5- and 12- Distribution Point Systems