Chapter 3
Network Planning
1
Three Hierarchical Steps
• Network design
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–
–
–
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?
2
3.2 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
3
Key Strategic Decisions
•
•
•
•
•
•
Number of facilities.
Location of each facility.
Size of each facility.
Allocating space for products.
Sourcing requirements.
Determining distribution strategies
Objective: Design or reconfigure the logistics
network in order to minimize annual systemwide cost subject to a variety of service level
requirements
4
Data Collection & Aggregation
• 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
Customer Zones & Product Groups
5
Transportation Rates
Rates linear with distance but not volume
Internal
TL - Zone-to-zone costs provides cost per
mile per truckload between any two
zones.
LTL – Class, Exception & Commodity Rates
Mileage estimation
6
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.
7
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
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–
–
–
access and handling
aisles,
picking, sorting and processing facilities
AGVs
• Typical factor value = 3
8
Potential 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
9
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
10
Future Demand
• Strategic decisions have to be valid for 3-5
years
• Consider scenario approach and net present
values to factor in expected future demand
over planning horizon
11
Number of Warehouses
Optimal
Number
of Warehouses
$90
$80
Cost (millions $)
$70
$60
Total Cost
Transportation Cost
Fixed Cost
Inventory Cost
$50
$40
$30
$20
$10
$-
0
2
4
6
8
10
Number of Warehouses
12
Sexy 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.
13
Unit Distribution Costs
Facility
warehouse
p1
p2
c1
c2
c3
w1
0
4
3
4
5
w2
5
2
2
1
2
Two heuristics and an optimization technique:
1. Choose the cheapest warehouse to source demand
2. Choose the warehouse where the total delivery
costs to and from the warehouse are the lowest
3. LP
Heuristic #1:
Choose the Cheapest Warehouse to Source Demand
D = 50,000
$2 x 50,000
$5 x 140,000
Cap = 60,000
$2 x 60,000
D = 100,000
$1 x 100,000
$2 x 50,000
D = 50,000
Total Costs = $1,120,000
15
Heuristic #2:
Choose the warehouse where the total delivery costs to and
from the warehouse are the lowest
[Consider inbound and outbound distribution costs]
$0
D = 50,000
$3
$5
$4
$2
$5
$3
$7
$7
$4
D = 100,000
$4
Cap = 60,000
P1 to WH1
P1 to WH2
P2 to WH1
P2 to WH 2
P1 to WH1
P1 to WH2
P2 to WH1
P2 to WH 2
$1
$2
$2
$4
$6
$8
$3
D = 50,000
P1 to WH1
P1 to WH2
P2 to WH1
P2 to WH 2
$5
$7
$9
$4
Market #1 is served by WH1, Markets 2 and 3
are served by WH2
16
Heuristic #2:
Choose the warehouse where the total delivery costs to and
from the warehouse are the lowest
[Consider inbound and outbound distribution costs]
$0 x 50,000
D = 50,000
$3 x 50,000
Cap = 200,000
P1 to WH1
P1 to WH2
P2 to WH1
P2 to WH 2
$5 x 90,000
D = 100,000
$1 x 100,000
Cap = 60,000
$3
$7
$7
$4
$2 x 60,000
$2 x 50,000
P1 to WH1
P1 to WH2
P2 to WH1
P2 to WH 2
$4
$6
$8
$3
D = 50,000
P1 to WH1
P1 to WH2
P2 to WH1
P2 to WH 2
$5
$7
$9
$4
Total Cost = $920,000
17
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
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The Optimization Model
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.
19
Optimal Solution
Facility
warehouse
p1
p2
c1
c2
c3
w1
140,000
0
50,000
40,000
0*
w2
0
60,000
0
60,000
50,000*
Total cost for the optimal strategy is $740,000
*Your text has the w2c3 and w1c3 numbers reversed
DSS for Network Design
• Flexibility to incorporate a large set of preexisting network
characteristics
• Other Factors:
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Customer-specific service level requirements.
Existing warehouses kept open
Expansion of existing warehouses.
Specific flow patterns maintained
Warehouse-to-warehouse flow possible
Production and Bill of materials details may be important
• Robustness
– Relative quality of the solution independent of specific environment,
data variability or specific settings
21
Inventory Positioning and Logistics Coordination
• Multi-facility supply chain that belongs to a single firm
• 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?
22
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.
– SI  T  S
• Net Lead Time = SI + T - S
• Safety stock at the facility:
zh SI  T  S
23
2-Stage System

Reducing committed service time from facility 2
to facility 1 impacts required inventory at both
facilities
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

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.
24
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 => Low customer promise times
< Manufacturing Lead Times
• High inventory of SKUs based on long-term forecasts =>
Classic PUSH STRATEGY
– High shortages
– Huge risk
• PULL STRATEGY not feasible because of long lead times
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New Supply Chain Strategy
•
OBJECTIVES:
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ACHIEVE THE FOLLOWING:
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Push Stages produce to stock where the company keeps safety stock
Pull stages keep no stock at all.
Challenge:
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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
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–
•
Reduce inventory and financial risks
Provide customers with competitive response times.
Identify the location where the strategy switched from Push-based to Pullbased
Identify the Push-Pull boundary
Benefits:
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–
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%
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Notations Used
FIGURE 3-11: How to read the diagrams
27
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.
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Current Safety Stock Location
FIGURE 3-12: Current safety stock location
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Optimized Safety Stock Location
FIGURE 3-13: Optimized safety stock
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Current Safety Stock with Lesser Lead Time
FIGURE 3-14: Optimized safety stock with reduced lead time
31
Supply Chain with
More Complex Product Structure
FIGURE 3-15: Current supply chain
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Optimized Supply Chain with
More Complex Product Structure
FIGURE 3-16: Optimized supply chain
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Key Points
•
•
Identifying the Push-Pull boundary
Taking advantage of the risk pooling concept
– Demand for components used by a number of finished
products has smaller variability and uncertainty than that
of the finished goods.
•
Replacing traditional supply chain strategies that
are typically referred to as sequential, or local,
optimization by a globally optimized supply chain
strategy.
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Local vs. Global Optimization
FIGURE 3-17: Trade-off between quoted lead time and safety stock35
Global Optimization
• For the same lead time, cost is reduced
significantly
• For the same cost, lead time is reduced
significantly
• Trade-off curve has jumps in various places
– Represents situations in which the location of the
Push-Pull boundary changes
– Significant cost savings are achieved.
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Problems with Local Optimization
• Prevalent strategy for many companies:
– try to keep as much inventory close to the customers
– hold some inventory at every location
– hold as much raw material as possible.
• This typically yields leads to:
– Low inventory turns
– Inconsistent service levels across locations and products,
and
– The need to expedite shipments, with resulting increased
transportation costs
37
Integrating Inventory Positioning and
Network Design
• 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?
38
Integrating Inventory Positioning and
Network Design
FIGURE 3-18: Sample plot of each SKU by volume and demand
39
Three Different Product Categories
• High variability - low volume products
• Low variability - high volume products, and
• Low variability - low volume products.
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 tracks 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