1. 3-1 Session 3 Network Planning

2. 3-2 Why Network Planning? Find the right balance between inventory, transportation and manufacturing costs, Match supply and demand under uncertainty by positioning and managing inventory effectively, Utilize resources effectively by sourcing products from the most appropriate manufacturing facility

3. 3-3 Three Hierarchical Steps Network design Number, locations and size of manufacturing plants and warehouses Assignment of retail outlets to warehouses Major sourcing decisions Typical planning horizon is a few years. Inventory positioning: Identifying stocking points Selecting facilities that will produce to stock and thus keep inventory Facilities that will produce to order and hence keep no inventory Related to the inventory management strategies Resource allocation: Determine whether production and packaging of different products is done at the right facility What should be the plants’ sourcing strategies? How much capacity each plant should have to meet seasonal demand?

4. 3-4 Network Design Physical configuration and infrastructure of the supply chain. A strategic decision with long-lasting effects on the firm. Decisions relating to plant and warehouse location as well as distribution and sourcing

5. 3-5 Key Strategic Decisions Determining the appropriate number of facilities such as plants and warehouses. Determining the location of each facility. Determining the size of each facility. Allocating space for products in each facility. Determining sourcing requirements. Determining distribution strategies, i.e., the allocation of customers to warehouse

6. 3-6 Objective and Trade-Offs Objective: Design or reconfigure the logistics network in order to minimize annual system-wide cost subject to a variety of service level requirements Increasing the number of warehouses typically yields: An improvement in service level due to the reduction in average travel time to the customers An increase in inventory costs due to increased safety stocks required to protect each warehouse against uncertainties in customer demands. An increase in overhead and setup costs A reduction in outbound transportation costs: transportation costs from the warehouses to the customers An increase in inbound transportation costs: transportation costs from the suppliers and/or manufacturers to the warehouses.

7. 3-7 Data Collection Locations of customers, retailers, existing warehouses and distribution centers, manufacturing facilities, and suppliers. All products, including volumes, and special transport modes (e.g., refrigerated). Annual demand for each product by customer location. Transportation rates by mode. Warehousing costs, including labor, inventory carrying charges, and fixed operating costs. Shipment sizes and frequencies for customer delivery. Order processing costs. Customer service requirements and goals. Production and sourcing costs and capacities

8. 3-8 Data Aggregation Customer Zone Aggregate using a grid network or other clustering technique for those in close proximity. Replace all customers within a single cluster by a single customer located at the center of the cluster Product Groups Distribution pattern Products picked up at the same source and destined to the same customers Logistics characteristics like weight and volume. Product type Product models or style differing only in the type of packaging.

9. 3-9 Replacing Original Detailed Data with Aggregated Data Technology exists to solve the logistics network design problem with the original data, but data aggregation still useful because forecast demand is significantly more accurate at the aggregated level Aggregating customers into about 150-200 zones usually results in no more than a 1 percent error in the estimation of total transportation costs

10. 3-10 Warehouse Costs Handling costs Labor and utility costs Proportional to annual flow through the warehouse. Fixed costs All cost components not proportional to the amount of flow Typically proportional to warehouse size (capacity) but in a nonlinear way. Storage costs Inventory holding costs Proportional to average positive inventory levels.

11. 3-11 Determining Fixed Costs Warehouse fixed costs as a function of the warehouse capacity

12. 3-12 Determining Storage Costs Multiply average inventory level by holding cost It can be calculated through the use of Inventory Turnover = Annual Sales / Average Inventory Level

13. 3-13 Warehouse Capacity Estimation of actual space required Average inventory level = Annual flow through warehouse/Inventory turnover ratio Space requirement for item = 2*Average Inventory Level Multiply by factor to account for access and handling aisles, picking, sorting and processing facilities AGVs Typical factor value = 3

14. 3-14 Warehouse Capacity Example Annual flow = 1,000 units Inventory turnover ratio = 10.0 Average inventory level = 100 units Assume each unit takes 10 sqft. of space Required space for products = 2,000 sqft. Total space required for the warehouse is about 6,000 square feet

15. 3-15 Potential Warehouse Locations Geographical and infrastructure conditions. Natural resources and labor availability. Local industry and tax regulations. Public interest. Not many will qualify based on all the above conditions

16. 3-16 Service Level Requirements Specify a maximum distance between each customer and the warehouse serving it Proportion of customers whose distance to their assigned warehouse is no more than a given distance 95% of customers be situated within 200 miles of the warehouses serving them Appropriate for rural or isolated areas

17. 3-17 Solution Techniques Mathematical optimization techniques: 1. Exact algorithms: find optimal solutions 2. Heuristics: find “good” solutions, not necessarily optimal Simulation models: provide a mechanism to evaluate specified design alternatives created by the designer.

18. 3-18 Example Single product Two plants p1 and p2 Plant p2 has an annual capacity of 60,000 units. The two plants have the same production costs. There are two warehouses w1 and w2 with identical warehouse handling costs. There are three markets areas c1,c2 and c3 with demands of 50,000, 100,000 and 50,000, respectively.

19. 3-19 Unit Distribution Costs Facility warehouse p1p1p2p2c1c1c2c2c3c3 w1w104345 w2w252212

20. 3-20 Heuristic #1: Choose the Cheapest Warehouse to Source Demand D = 50,000 D = 100,000 D = 50,000 Cap = 60,000 $5 x 140,000 $2 x 60,000 $2 x 50,000 $1 x 100,000 $2 x 50,000 Total Costs = $1,120,000

21. 3-21 Heuristic #2: Choose the warehouse where the total delivery costs to and from the warehouse are the lowest [Consider inbound and outbound distribution costs] D = 50,000 D = 100,000 D = 50,000 Cap = 60,000 $4 $5 $2 $3 $4 $5 $2 $1 $2 $0 P1 to WH1$3 P1 to WH2$7 P2 to WH1$7 P2 to WH 2$4 P1 to WH1$4 P1 to WH2$6 P2 to WH1$8 P2 to WH 2$3 P1 to WH1$5 P1 to WH2$7 P2 to WH1$9 P2 to WH 2$4 Market #1 is served by WH1, Markets 2 and 3 are served by WH2

22. 3-22 D = 50,000 D = 100,000 D = 50,000 Cap = 60,000 Cap = 200,000 $5 x 90,000 $2 x 60,000 $3 x 50,000 $1 x 100,000 $2 x 50,000 $0 x 50,000 P1 to WH1$3 P1 to WH2$7 P2 to WH1$7 P2 to WH 2$4 P1 to WH1$4 P1 to WH2$6 P2 to WH1$8 P2 to WH 2$3 P1 to WH1$5 P1 to WH2$7 P2 to WH1$9 P2 to WH 2$4 Total Cost = $920,000 Heuristic #2: Choose the warehouse where the total delivery costs to and from the warehouse are the lowest [Consider inbound and outbound distribution costs]

23. 3-23 The Optimization Model The problem described earlier can be framed as the following linear programming problem. Let x(p1,w1), x(p1,w2), x(p2,w1) and x(p2,w2) be the flows from the plants to the warehouses. x(w1,c1), x(w1,c2), x(w1,c3) be the flows from the warehouse w1 to customer zones c1, c2 and c3. x(w2,c1), x(w2,c2), x(w2,c3) be the flows from warehouse w2 to customer zones c1, c2 and c3

24. 3-24 The problem we want to solve is: min 0x(p1,w1) + 5x(p1,w2) + 4x(p2,w1) + 2x(p2,w2) + 3x(w1,c1) + 4x(w1,c2) + 5x(w1,c3) + 2x(w2,c1) + 2x(w2,c3) subject to the following constraints: x(p2,w1) + x(p2,w2)  60000 x(p1,w1) + x(p2,w1) = x(w1,c1) + x(w1,c2) + x(w1,c3) x(p1,w2) + x(p2,w2) = x(w2,c1) + x(w2,c2) + x(w2,c3) x(w1,c1) + x(w2,c1) = 50000 x(w1,c2) + x(w2,c2) = 100000 x(w1,c3) + x(w2,c3) = 50000 all flows greater than or equal to zero. The Optimization Model

25. 3-25 Optimal Solution Facility warehouse p1p1p2p2c1c1c2c2c3c3 w1w1140,000050,00040,00050,000 w2w2060,0000 0 Total cost for the optimal strategy is $740,000

26. 3-26 Simulation Models Useful for a given design and allow user to perform micro-level analysis. Examine: Individual ordering pattern. Specific inventory policies. Inventory movements inside the warehouse. Not an optimization model Can only consider very few alternate models

27. 3-27 Which One to Use? Use mathematical optimization for static analysis Use a 2-step approach when dynamics in system has to be analyzed: Use an optimization model to generate a number of least-cost solutions at the macro level, taking into account the most important cost components. Use a simulation model to evaluate the solutions generated in the first phase.

28. 3-28 Inventory Positioning and Logistics Coordination Manage inventory so as to reduce system wide cost Consider the interaction of the various facilities and the impact of this interaction on the inventory policy of each facility Ways to manage: Wait for specific orders to arrive before starting to manufacture them [make-to-order facility] Otherwise, decide on where to keep safety stock? Which facilities should produce to stock and which should produce to order? Consider a multi-facility supply chain that belongs to a single firm

29. 3-29 Single Product, Single Facility Periodic Review Inventory Model Assume - SI: amount of time between when an order is placed until the facility receives a shipment (Incoming Service Time) S: Committed Service Time made by the facility to its own customers. T: Processing Time at the facility. Assume: SI + T > S (otherwise, no inventory is needed at the facility) Net Lead Time = SI + T - S Safety stock at the facility:

30. 3-30 2-Stage System Reducing committed service time from facility 2 to facility 1 impacts required inventory at both facilities Inventory at facility 1 is reduced Inventory at facility 2 is increased Overall objective is to choose: the committed service time at each facility the location and amount of inventory minimize total or system wide safety stock cost.

31. 3-31 ElecComp Case Large contract manufacturer of circuit boards and other high tech parts. About 27,000 high value products with short life cycles Fierce competition => Committed service times to customers < Manufacturing Lead Times High inventory of SKUs based on long-term forecasts => Classic PUSH STRATEGY Financial and Shortage Risks Not an appropriate strategy But PULL STRATEGY not feasible also because of long lead times

32. 3-32 New Supply Chain Strategy OBJECTIVES: Reduce inventory and financial risks Provide customers with competitive response times. ACHIEVE THE FOLLOWING: Determining the optimal location of inventory across the various stages Calculating the optimal quantity of safety stock for each component at each stage Hybrid strategy of Push and Pull Push Stages produce to stock where the company keeps safety stock Pull stages keep no stock at all. Challenge: Identify the location where the strategy switched from Push-based to Pull-based Identify the Push-Pull boundary Benefits: For same lead times, safety stock reduced by 40 to 60% Company could cut lead times to customers by 50% and still reduce safety stocks by 30%

33. 3-33 Notations Used How to read the diagrams

34. 3-34 Trade-Offs If Montgomery facility reduces committed lead time to 13 days assembly facility does not need any inventory of finished goods Any customer order will trigger an order for parts 2 and 3. Part 2 will be available immediately, since it is held in inventory Part 3 will be available in 15 days 13 days committed response time by the manufacturing facility 2 days transportation lead time. Another 15 days to process the order at the assembly facility Order is delivered within the committed service time. Assembly facility produces to order, i.e., a Pull based strategy Montgomery facility keeps inventory and hence is managed with a Push or Make-to-Stock strategy.

35. 3-35 Current Safety Stock Location Current safety stock location Brown boxes: outside suppliers Back boxes: internal stages within ElecComp’s supply chain Assembly facility commits a 30-day response time  keeps inv. of finished goods Both assembly facility and facility manufacturing Part 2 produce to stock!

36. 3-36 Optimized Safety Stock Location Optimized safety stock Assembly facility & facility producing part 2 produce to order: no inventory Montgomery facility produce to stock (15>13), and keeps inv. of part 5 (due to 37+3>7+28, 32+3 Raleigh produces to order (8<32) but keeps inv. of part 7

37. 3-37 Safety Stock with Lesser Lead Time Optimized safety stock with reduced lead time Assembly facility produce to order, but keeps inv. of part 3 Facility manufacturing part 2 produces to stock Montgomery facility produce to order, but keeps inv. of part 5 Raleigh produces to order, but keeps inv. of part 7

38. 3-38 Consider a two-tier supply chain Items shipped from manufacturing facilities to primary warehouses From there, they are shipped to secondary warehouses and finally to retail outlets How to optimally position inventory in the supply chain? Should every SKU be positioned both at the primary and secondary warehouses?, OR Some SKU be positioned only at the primary while others only at the secondary? Integrating Inventory Positioning and Network Design

39. 3-39 Three Different Product Categories High variability - low volume products Low variability - high volume products, and Low variability - low volume products.

40. 3-40 Supply Chain Strategy Different for the Different Categories High variability low volume products Inventory risk the main challenge for Position them mainly at the primary warehouses demand from many retail outlets can be aggregated reducing inventory costs. Low variability high volume products Position close to the retail outlets at the secondary warehouses Ship fully loaded trucks as close as possible to the customers reducing transportation costs. Low variability low volume products Require more analysis since other characteristics are important, such as profit margins, etc.

41. 3-41 Resource Allocation Supply chain master planning The process of coordinating and allocating production, and distribution strategies and resources to maximize profit or minimize system-wide cost Process takes into account: interaction between the various levels of the supply chain identifies a strategy that maximizes supply chain performance

42. 3-42 Global Optimization and DSS FACTORS TO CONSIDER Facility locations: plants, distribution centers and demand points Transportation resources including internal fleet and common carriers Products and product information Production line information such as min lot size, capacity, costs, etc. Warehouse capacities and other information such as certain technology (refrigerators) that a specific warehouse has and hence can store certain products Demand forecast by location, product and time.

43. 3-43 Focus of the Output Sourcing Strategies: where should each product be produced during the planning horizon, OR Supply Chain Master Plan: production quantities, shipment size and storage requirements by product, location and time period. Output of the planning process may focus on either:

44. 3-44 Questions to Ask During the Planning Process Will leased warehouse space alleviate capacity problems? When and where should the inventory for seasonal or promotional demand be built and stored? Can capacity problems be alleviated by re-arranging warehouse territories? What impact do changes in the forecast have on the supply chain? What will be the impact of running overtime at the plants or out-sourcing production? What plant should replenish each warehouse? Should the firm ship by sea or by air. Shipping by sea implies long lead times and therefore requires high inventory levels. On the other hand, using air carriers reduces lead times and hence inventory levels but significantly increases transportation cost. Should we rebalance inventory between warehouses or replenish from the plants to meet unexpected regional changes in demand?