Network design and optimization 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

Strategic Planning Overview External Environment Economic Regulatory Technological Competitive Internal Factors Strengths Weaknesses Opportunities Threats Corporate Objectives & Strategy SWOT PEST Competitive Strategy Functional strategic plans marketing production finance logistics The handbook of Logistics & Distribution Management 4th Edition

PEST Analysis Political / Legal Monopolies legislation Environmental protection laws Taxation policies Foreign trade regulations Employment law Government stability Economic Business cycles Interest rates Money supply, inflation Unemployment Disposable income Energy availability costs Socio-cultural Population demographics Income distribution Social mobility Lifestyle changes Attitude to work & leisure Consumerism Education levels Technological Government spending on research Government & industry focus on technological effort New discoveries / developments Speed of technology transfer Rates of obsolescence

Logistics Network Design Includes aspects related to the physical flow of the product through a company’s operation, the inventory that should be held, the number and location of warehouses, the use of stockless warehouses, and final product delivery. One key to the determination of an appropriate physical design is the use of trade-offs between logistics competencies and between the different company functions. Corporate Objectives & Strategy Competitive Strategy Logistics process design Logistics network design Logistics information system design Logistics organizational structure The handbook of Logistics & Distribution Management 4th Edition

Logistics Network Design Corporate Objectives & Strategy Competitive Strategy Competitive Strategy Logistics process design Logistics network design Logistics information system design Logistics organizational structure The handbook of Logistics & Distribution Management 4th Edition

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 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 use 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: 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: consolidation 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: inventory 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 Must achieve freight consolidation with warehouse positioning Inventory storage to support customized orders Mixing facilities to support flow-through and cross-dock sorting Based on providing service or cost advantage

Key design questions to ask 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 Order processing Inventory Transportation 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

seeks to quantify trade-offs between logistics functions Systems analysis Focus on process perspective balancing performance between functional areas both within the enterprise and across its supply chain Components linked together in a balanced system will produce greater end results than possible through individual performance seeks to quantify trade-offs between logistics functions

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 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 13.2 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?

Additional warehouses typically reduce total in-transit inventory 6 days 6 days 10 days 4 days Results Figure 13.3 Logistical Network: Two Markets, One Warehouse Figure 13.4 Logistical Network: Two Markets, Two Warehouses Table 13.1 Transit Inventory under Different Logistical Networks

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 Modeling Steps

Strategic importance of network design Critical variables in network design: Changing Customer Service Requirements Shifting Locations of Customer and/or Supply Markets Change in Corporate Ownership Cost Pressures Competitive Capabilities Corporate Organizational Change

High-level Modeling Steps

Network design process

Analysis (example)

Recommendations and Implement

Network Design: Step 1 Step 1: Define Network Strategy & Requirements Form a design team Includes the overall system including business strategy requirements and relevant constraints, such as planning and environmental issues. Also includes approaches described in business and supply chain strategy literature, such as on competitive advantage and consumer value and the use of scenario planning Management of Business Logistics, 7th Ed. Chapter 14

Network Design: Step 2 & 3 Step 2: Perform a Logistics Audit & Collect Data Forces a comprehensive perspective Develops essential information These include product details, order profiles, shipping patterns, cost data and site information Step 3: Examine the Logistics Network Alternatives Use modeling to provide additional insights Develop preliminary designs Test model for sensitivity to key variables Management of Business Logistics, 7th Ed. Chapter 14

Logistics Audit Logistics Strategic Plan Strategic Logistics Issues Logistics Provider Selection and Evaluation Key Logistics Activities Logistics System Fundamental Business Information

Network Design: Steps 4 & 5 Step 4: Conduct a Facility Location Analysis Analyze attributes of candidate sites Apply screening to reduce alternative sites Step 5: Make Decisions regarding Network and Facility Location Evaluate sites for consistency with design criteria. Confirm types of change needed

Logistics Network Design Step 6: Develop an Implementation Plan Plan serves as a road map in moving from current system to the desired logistics network. Firm must commit funds to implement the changes recommended by the re-engineering process.

Major Locational Determinants Regional Determinants Site-Specific Determinants Labor climate Transportation access Availability of transportation Truck Proximity to markets Air Quality of life Rail Taxes & other incentives Water Supplier networks Inside/outside metro area Land costs and utilities Availability of workforce Company preference Utilities

Major Locational Determinants: Current Trends Governing Site Selection Strategic positioning of inventories, with faster moving items located at “market-facing” logistics facilities, and slower moving items at national or regional sites. Direct plant-to-customer shipments which can reduce or eliminate the need for company-owned supply or distribution facilities. Growing need and use of “cross-docking” facilities. Use of third party logistics companies which negate the need for the firm to maintain or establish its own distribution facilities.

Supply Chain Scenario for Network Analysis Raw Materials Warehouse Manufacture Distribution Center Retail

Modeling Approaches: Optimization Models Based on precise mathematical procedures guaranteed to find the “best” solution from among a number of feasible solutions. One approach is Linear Programming (LP). Useful in linking facilities in a network. Defines optimum distribution patterns. Modern computers facilitate LP modeling.

Modeling Approaches: Simulation Models Based on developing a model of a real system and conducting experiments with this model. In location theory, a firm can test the effect of various locations on costs and profitability. Does not guarantee an optimum solution but evaluates through the iterative process. Simulations are either static or dynamic depending upon how whether they incorporate data from each run into the next run.

Modeling Approaches: Heuristic Models Based upon developing a model that can provide a good approximation to the least-cost location in a complex decision problem. Can reduce a problem to a manageable size. This approach can be as sophisticated as mathematical optimization approaches. The “Grid Technique” is an example of a heuristic approach and will be demonstrated in the next few slides.

Heuristic Modeling Approach: The Grid Technique The Grid Technique attempts to locate a fixed facility such that the location represents the least-cost center for moving inbound materials and outbound product within a geographic grid. It finds the ton-mile center of mass; that is, the geographic point where transportation costs are minimized (as discussed in class) This simple approach works where all transportation rates are the same. However, we know that freight rates for raw materials are generally lower than those for finished goods.

Example of: The Grid Technique When we use different freight rates, the grid model will tend to pull the location of our fixed facility toward the higher rated areas. Thus, the location of a production plant will tend to be nearer the market, reducing the overall transportation of the higher rated finished goods in favor of increasing transportation of lower rated raw materials.

Heuristic Modeling Approach: The Grid Technique Advantages Simple to use Provides a starting point for further analysis Can accommodate “what if” questions Limitations Static approach Linear rates No consideration of topography Does not consider direction of movement

Total cost of the network Figure 13.6 combines cost curves from Figure 13.2 and 13.5 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

Figure 13.6 Least-Total-Cost Network Total cost concept Figure 13.6 Least-Total-Cost Network

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

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