Distribution Networks
Pierre Semal, UCL School of Management, Belgium
IFG Logistics
September, 2000
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0.
Introduction ...................................................................................................................................................................................................................................................... 3
0.1.
Contents .................................................................................................................................................................................................................................................... 3
0.2.
Central Question: ...................................................................................................................................................................................................................................... 4
0.3.
Course Objectives: .................................................................................................................................................................................................................................... 5
1. Components and Environment.......................................................................................................................................................................................................................... 6
2. Network Design: general approach................................................................................................................................................................................................................... 9
3. Customer Service: ........................................................................................................................................................................................................................................... 10
3.1.
Definition of Customer Service .............................................................................................................................................................................................................. 10
3.2.
Elements of Customer service ................................................................................................................................................................................................................ 11
3.3.
Set objectives for customer service......................................................................................................................................................................................................... 13
4. Channel Structure ........................................................................................................................................................................................................................................... 20
4.1.
Examples ................................................................................................................................................................................................................................................ 20
4.2.
Function of channel Intermediaries ........................................................................................................................................................................................................ 22
4.3.
Channel Issues ........................................................................................................................................................................................................................................ 23
5. Motivations for (re-)designing the Network ................................................................................................................................................................................................... 25
5.1.
Changes in .............................................................................................................................................................................................................................................. 25
5.2.
Cost Pressure .......................................................................................................................................................................................................................................... 25
5.3.
Competition ............................................................................................................................................................................................................................................ 25
6. The distribution network design process ........................................................................................................................................................................................................ 26
6.1.
Project Management ............................................................................................................................................................................................................................... 27
6.2.
Set Objectives for the channels and for customer service ....................................................................................................................................................................... 28
6.3.
Data and Design Variables ..................................................................................................................................................................................................................... 29
6.4.
Audit the current network ....................................................................................................................................................................................................................... 30
6.5.
Cost Models ............................................................................................................................................................................................................................................ 31
6.6.
Other Models .......................................................................................................................................................................................................................................... 38
6.7.
Analysis of alternative solutions ............................................................................................................................................................................................................. 39
6.8.
Facility Location ..................................................................................................................................................................................................................................... 41
7. Bibliography ................................................................................................................................................................................................................................................... 44
8. Case: Llenroc Plastics Europe ........................................................................................................................................................................................................................ 45
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0. Introduction
0.1. Contents
Central Question and Course Objectives
Course Contents
 Components and Environment
 Customer Service
 Distribution Channel Structure
 Network Design
References
Case: Llenroc Plastics Europe
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0.2. Central Question:
 What is a distribution network
 How to design a Distribution Network
 How to evaluate the performance of a Distribution Network
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0.3. Course Objectives:
After the course, the students should :
 Understand what “Distribution Network Design” (DND) is;
 Understand the strategic dimension of DND;
 Understand the relationships between DND and other
functions;
 Be able to develop a methodology for DND;
 Know and be able to apply the basic quantitative and
qualitative methods underlying DND;
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1. Components and Environment
Customer
Service
Strategic
Channel
Design
Network
Strategy
Structural
Warehouse
Design & Op.
Transportation
Management
Material
Management
Functional
Information
System
Policies and
Procedures
Facilities and
Equipment
Change
Management
Implementation
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This section aims at analysing quickly in what consist a logistics strategy and a logistics system. Therefore, we will review the different components of a logistics strategy.
This will allow us to understand the role played by “distribution network design” (DND) in the logistics strategy and give us a first rough methodology for DND.
The figure, drawn from “Andersen Consulting: service Mark, 1989”, identifies in a logistics system 10 components organized in 4 levels. Of course, these components should
be fully coordinated and integrated for the system to reach its best performance. Let us first review quickly these components.
Strategic : Customer Service
The customer drives the whole supply chain: from purchasing, through manufacturing up to the delivery. The idea is therefore to start with the identification of what the
customers want and value. This will allow us to identify different groups of customers with different service requirements (segments). The identification of the different
segments and of the service they require allows the company first to develop a strategy and second to allocate the resources and efforts accordingly. Basically, the selection of
a strategy requires the following two questions to be addressed:
- What capabilities are necessary to meet customers needs ?
- How can our logistics system bring a useful competitive advantage ?
The goal of this strategic step is thus to define qualitatively and quantitatively the service we would like the logistic system to provide to each group of customers. In order to
fix ideas and to give examples of customer service, a company could aim at providing a group of OEM with a convenient EDI order system and with an error-free and ontime delivery system; the company could also try to provide a set of wholesalers with cheap bulk deliveries; etc.
More details on customer service is given in section 3.
Structural : Channel and Physical Network Design
Once the service to be provided to a given customer has been selected, a system needs to be designed in order to achieve this service. Two main components can be identified
at this level (the structural level): the channel structure and the physical distribution network.
The channel refers to the set of players between the manufacturer and the final customers. Typical questions at this level are: - Do we serve the customers directly or do we
make use of wholesalers, retailers, agents ?
If we do make use of intermediaries, which role will they play in the achievement of the service that has to be provided?
Again, we will give more details on the methodology required to address this point later in this text.
The network of physical facilities also called distribution network is the second structural element of a logistics system. The questions to be addressed at this level are:
1. How does the network of facilities look like (how many facilities, of which type, which location) ?
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2. How will the products flow through this network from the manufacturing to the customers ?
3. How will the return products and the information flow in this network ?
If the company does not deliver the final customers directly, then the company network and its design should be integrated with that of the next intermediary (retailer,
distributor, wholesaler) in the channel. This need for integration also exists for the manufacturing function and in some cases for the manufacturing supply function. Indeed,
the final measure is the level of service the customer perceives; and this level is a function of the complete chain.
The design of the physical network thus aims at meeting the goals that have been set in terms of customer service for each of the channels. This design is also guided by two
other objectives:
- reduce cost in order to avoid to transform the competitive advantage achieved by this superior service into a competitive disadvantage in terms of cost and
- maintain flexibility in order to be able to react to internal and external changes that can happen in the future.
Functional level
Here we focus on the operations of each component of the logistics systems.
Warehouse:
how do we operate them (in bound and out bound operations) ?
Material:
what is the complete replenishment process both for supplying, manufacturing and warehousing
Transportation how do we select, schedule and control the carriers ?
Again, the individual performance of a component is of no importance! Only the total performance perceived by the final customer counts. This calls again for a global
analysis of the processes.
Implementation level
At the implementation level, we are faced with the information system, with the policies and the procedures with the local facilities and equipment, that is, with all what is
required to perform everyday’s operations. Human management is also part of these everyday’s operations.
Different chapters of this course provide details about these components.
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2. Network Design: general approach
The description of the components of a logistics system allows us to elaborate a first rough methodology for network design:
Network design is located at the structural level
 details on Customer Service and Channel Structure
 rough information on lower levels
From a theoretical point of view, all the ten components of a logistics system interfere. That would mean that we cannot modify a single component without influencing all
the other components. The design of the physical network would then become a huge if not impossible task. Every detail of the system has then to be optimised at the same
time. This is in reality impossible.
Fortunately, the organization of the ten components shows some hierarchy. This hierarchy can be used to reduce the breadth of the problem (Such a hierarchical approach is
very common in production planning).
First of all, the customer service is of highest importance. Indeed, it does not make sense to design the physical network if we do not know the objectives we want to achieve
with this network. The same is true for the channel design. We need to know whom we are servicing before we can start the planning of the physical network. Therefore,
detailed information on customer service and channel structure is required before hand.
The other components should also be investigated before we start the design of the physical network. For example, we should have an idea on the kind of information system
we will use or we can use. We should for example know whether the information would be real time or not. We do not need details on the technology that will be used for the
information system to provide this real time information.
The structure of the rest of the chapter follows this approach. First, we will get detailed information on customer service and on channel structure. Then and only then, we
will look at the design of the physical network.
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3. Customer Service:
In this section, we will successively look at the meaning of customer service, analyse its various elements and finally see how a coherent strategy in terms of customer service
can be decided.
3.1. Definition of Customer Service
what is customer service ?
 is the output of the logistics system
Basically, the complete logistics system is designed and operated in order to bring the product (or service) to the customer where he wants it and when he wants it.
 provides place and time utility
As the manufacturing process builds the form utility of a product, the logistics function builds its time and place utility.
 is basically related to the availability of the product or of the service
 can be seen:
as a set of activities
All the activities required to accept, process, deliver and bill customer orders and to follow activities that erred.
as a set of performance measures
The list of measures can be extremely long. An example is given the percentage of customer orders received and processed within 24 hours.
as a set of practical indicators
Since customer service can be seen as a set of performance, it can also be seen as a set of practical indicators used for the management of the logistics process itself.
as corporate philosophy
All the activities that lead to a happy customer and the advance of the company’s objectives.
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3.2. Elements of Customer service
More information on customer service can be found in the chapter …
The customer service is the output of the logistics system. It is therefore made of all the interactions a customer can have with the logistic system. We can distinguish between
the interactions that occur before, during and after a transaction. The following list of elements is drawn from B.J. La Londe and P. Zinzer, “Customer Service: Meaning and
Measurement”, Chicago: National Council of Physical Distribution Management, 1982, 1-24.
Pre-transaction elements
 Written statement of customer service policy
Is there one, is it understood, is it communicated internally and externally, is it specific and measurable ?
 Organizational structure
Does the selected structure facilitate the successful implementation of customer service ?
Is there a customer service structure (a person) in place ? which level of control does it have ?
 System flexibility
Are we internally and externally flexible ? Can we adapt to particular customer needs ? Can we resist to unexpected events ?
 Management help
Do we help / train the customer to manage their inventories, to use the communication systems ?
Transaction elements
 Order information and convenience
How quickly do we answer to an information query ? Do we inform customers of problems ?
Are we easy to contact ? Do we provide different order mechanisms ? Open hours ?
 Order cycle time
What is the time from order to delivery ? Do we monitor it and its different components ?
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 Inventory availability
What percentage of orders are satisfied from stock ? Do we monitor it by product and customer ?
 Order fill rate
What percentage of orders are filled within stated lead-time ? Monitoring ?
 Expedite shipments
Do we design such shipments ? Which customer are entitled to get such service ?
 Substitutes
How many substitutes do we keep for each product ?
 System accuracy
Do we monitor all the different types of errors (product, customer, quantity, billing, condition, )
Post-transaction elements
 Installation, warranty, repairs, spares
Do we assist the customer for using the product ? What is the availability of spares / repairmen ? Do we provide the adequate documentation to the field force ?
 product tracing
Do we know who bought what ? Do we know how we built what ?
 Customer complaints, Returns, Replacement
Do we answer ? how quickly ? Do we use problem solution as a way to build contacts ?
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3.3. Set objectives for customer service
Now that we know what customer service refers to, we will propose a methodology (a blueprint) for selecting the objectives we really want our logistics system to achieve.
The main steps or data that are needed
1
2
3
4
5
6
Identify customers’ needs, the performance of the company and of its
competitors
Analyse customer behaviour
Analyse Cost/revenue trade-Offs
Perform ABC (Pareto) classifications
Analyse the environment
Analyse the corporate lines
We will detail these items here below.
Conclusion: A visioning process based on these data
 results in clear specification for the channel structure
 results in clear specification for the physical network design in terms of
Customer service, Cost and Flexibility
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3.3.1
Step 1:
Identify customers’ needs
This is also called the external customer service audit.
No two customers are the same. We should wonder what they want and ask them what they want. Remember the possible gap between the real customers’ expectations and
what managers think they expect.
 Identify key elements of customer service
The customers do not always attach the same importance to product attributes as the vendor does. The first step is therefore the identification of the factors that influence the
purchase decisions.
Even before this, we need to know who is taking the decisions. This is the person from whom the information should be collected
Here is an example of key customer service elements. This list should be updated according to the environment of the company.
Order cycle time
Documentation quality
Ordering convenience Technical support
What do we want to guarantee?
Includes quality of invoices and others.
Stock availability
Claims procedure
Frequency of delivery Order status
information
Order-size constraints
Order completeness
Delivery reliability
On-time order fill
What do we allow ? are we flexible ?
What percentage do we deliver complete?
What percentage is on-time ?
What percentage is on-time and complete?
The classical stockout probabilities.
 Establish the relative importance of those elements
By asking the customers (different rating systems are possible) or by statistical analysis (customers are given combination of services and then asked to choose; from the
results the importance of the different components are derived statistically).
Be aware that two levels of importance are needed. How important is customer service by comparison with the other elements of the marketing mix (product, price and
promotion) is one thing. The second level is the relative importance of the different customer service elements.
 Identify clusters of customers according to similarity of needs
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Very often, customers fall into groups or segments. Cluster analysis can help distinguishing these groups. In any case, being able to differentiate these groups allow to adapt
the service to the needs.
 Compare the company position with the priorities of the customers
This will basically lead to the following 4 quadrants with obvious conclusions.
High importance
Weakness
Low importance
Ok
Low performance
Strength
Useless efforts
High performance
 Identify company position on the key service elements relative to competition
This will tell you what are your competitive advantage and disadvantage. Typically, a weakness can become a disqualifying element if the competition is better than you and
a strength an “order winner” if the competition cannot perform as well as you do.
Tools: marketing research
A marketing research, by means for example of questionnaires, allows to know what the customers value and, at the same time, how the company performance is perceived.
Please refer to a “marketing research” textbook before conducting such an inquiry.
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3.3.2
analyse the reactions to a service failure
Once we know what the customers want, we need to decide what we will offer them. Several data should be collected and several viewpoints should be taken.
Assume a customer experiences a stockout: How will he react ?
The goal here is to measure the consequences of a service failure. Other examples can be taken.
Switch store ?
In this case, this is harmful for the retailer, not for the manufacturer.
Postpone ?
When the fidelity to the brand is high, a special order can be placed or the customer can simply wait for the next visit. However, the retailer can suffer.
Switch size ?
An important data, since it can push the manufacturer to have the different sizes available.
Switch brand ?
More dangerous for the manufacturer than for the retailer.
The clear identification of these reactions can give an idea of the importance of the service element. It could also lead to new strategies that take advantage of the knowledge
of this behaviour.
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3.3.3
Analyse cost/revenue trade-Offs
Here we take an economical perspective, looking at the cost of the service, at the profitability of products and of customers. This part is drawn from LASCM, p39-42.
 The different contributions of customers
Different customers buy different quantities; the cost to service different customers vary.
Typically, the Pareto law can be used. 80 % of the profit comes from 20% of the customers; 80% of the costs come from 20% of the customers.
Draw a chart with X = % of customers in decreasing order of profit contribution; Y= % of total profit. How does the curve look like ?
What are your conclusions ?
 The cost of providing a given level of service
Draw a chart with X= service level and Y= cost of service. How does the curve look like ?
What are your conclusions ?
This cost is the sum of inventory carrying costs, lot quantity costs, transportation costs, warehouse costs, order processing costs.
 The profit of customer service
Draw a chart with X= service level and Y= sales revenues. S shape
Put the last two curves together; derive profit and best service level.
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3.3.4
Perform ABC (Pareto) classifications
The Pareto curves shows that different customer service could be used for different products.
 ABC classification of products (Pareto curve)
The Pareto curve should be based on profits.
 use for inventory control
Different products lead to different profit levels. A possible consequence is that all the products do not require the same availability. We could decide that the availability of
the A products should be higher than that of the C products. This would be an adequate strategy if this classification corresponds to different customers. On the other hand, if
a same customer orders A and C products, this technique could be inappropriate.
 use for inventory location
Another strategy could be to decentralize the A product and centralize the C products.
 use with stock turn to derive strategies
The idea here is to build a matrix with X= stock turn and Y= profit. This matrix leads to the following decisions:
The (low profit - low stock-turn): review
The (low profit - high stock-turn): look for cost reductions
The (high profit -low stock-turn): look for JIT
The (high profit -high stock-turn): provide high availability
 ABC classification of customers (Pareto curve)
Determine the following arithmetic product. 20% of customers and 20% of products provide 64% of profit.
Build the matrix. (A-A) develop; (B-B) maintain; (C-C) review
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3.3.5
By the analysis of the environment
Competition environment
The analysis of the competitors has already been described in the point 3.3.1.
Technology environment
This is a main dimension quite often neglected. Many changes in the information and in the communication technology do affect the logistics system design. The concept of a
virtual warehouse in which data instead of goods are moved is a typical example.
Legal environment
This dimension is also crucial. Constraint on gas emission, for example, can affect the selection of a transportation strategy. Legal constraints also affect the social domain.
All these external factors must be systematically reviewed.
3.3.6
By the analysis of the corporate lines
Here we refer to the image and the lines followed by the company in general. The customer service must be consistent with these lines.
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4. Channel Structure
The selection of the channel structure is extremely crucial since in most cases, it will be extremely hard and expensive to modify it as soon as it has been implemented.
In this section, we will give examples of channel structures, explain the basic role of intermediaries and analyse the basic issues in channel design.
The channel refers to the set of players between the manufacturer and the final customers. These players will allow the exchange of the goods to occur. The products that are
exchanged can be consumer or industrial goods. Here are two set of channel examples drawn from SLM, p 72-73.
4.1. Examples
Alternative Channels of distribution for Consumer Goods
Manufacturer Manufacturer Manufacturer Manufacturer Manufacturer Manufacturer Manufacturer
↓
↓
↓
↓
↓
↓
↓
↓
↓
↓
↓
↓
Sales agent or Manufacturer
Broker
’s branch
↓
↓
↓
↓
↓
↓
↓
↓
↓
↓
↓
Wholesaler Wholesaler Wholesaler
↓
↓
↓
↓
↓
↓
↓
↓
Mail order
Own Shop
Retailer
Retailer
Retailer
Retailer
↓
↓
↓
↓
↓
↓
↓
Consumer
Consumer
Consumer
Consumer
Consumer
Consumer
Consumer
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Alternative Channels of distribution for Industrial Goods
Manufacturer Manufacturer Manufacturer Manufacturer
↓
↓
↓
↓
↓
Sales agent or
Sales agent or
Broker
Broker
↓
↓
↓
↓
↓
Industrial
Industrial
distributor
distributor
↓
↓
↓
↓
Industrial
Industrial
Industrial
Industrial
User
User
User
User
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4.2. Function of channel Intermediaries
Role of Intermediaries: to ease the contact between the
customers and the producers
The assortment offered by a manufacturer and the assortment required by a customer most often differ. The basic role of an intermediary is to reduce this discrepancy. The
need for an intermediary increases with the number of manufacturers and the number of customers that are in contacts.
Wholesalers:
 Sell to retailers or industrial users
 Maintain inventories of goods
 Break bulk into lots
 Assemble and sort goods in lots
Retailers:
 Make product available for end users
 Organize the end sales
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4.3. Channel Issues
 Intensity of distribution
Intensive: as many distributors as possible
The goal here is to reach as many customers as possible.
Exclusive: a limited and controlled set of distributors
With a limited number of distributors, the manufacturer can control the price and service offered to the custormers.
 Leverage along the chain
Manufacturer’s power
The manufacturer has the market power if the customers demand for its products (the brand name)
Wholesaler’s power
The wholesalers have the power when each retailers orders small quantities of products manufactured by different firms
Retailer’s power
The power of a retailer comes from the loyalty and the number of its customers.
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 Product features influencing the channel design
Here we just mention that different product features such as the technicality, the perishability or the substitutability do influence the
channel selection.
 Channel performance measurement
 Channel Control
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5. Motivations for (re-)designing the Network
5.1. Changes in
i. Corporate Ownership
Companies do evolve. New plants are bought, others are sold. The company change over time their focus.
ii. Changes in market/supply location
Globalisation and market openings allow new supplier and new customers to be considered.
iii. Customer service
Since the customers’ need do evolve, the logistics system must evolve. What was an order winner yesterday becomes a qualifier today. Competitive advantages do not last
forever.
5.2. Cost Pressure
Reducing the cost of a department is a never ending process. The logistics cost including warehousing, inventory and transportation costs is the target.
5.3. Competition
If we want to remain on the market place …
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6. The distribution network design process
Here is a kind of blueprint for the design or redesign of a distribution network. Its different components will be discusses in details.
1. Project Management
2. Set Objectives (channels and customer service)
3. Data and Design Variables
4. Audit the current network
5. Analysis of alternative solutions
6. Facility Location
7. Selection of network and location
8. Implementation
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6.1. Project Management
Since the modification of a logistics network is a major project that crosses that whole organization, a professional management of the project has to be organized.
This management should aim at avoiding the classical problems and at solving the classical difficulties encountered during the change induced by such a project.
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6.2. Set Objectives for the channels and
for customer service
In fact, this point was solved earlier (section 3). Just as a reminder, here is the structure that allowed the objectives for the DN design to be specified:
customers’ needs
company performance
competitors performance
customer behaviour
cost/revenue trade-Offs →
ABC classifications
environment analysis
corporate lines analysis
Channel Structure
Visioning process
resulting in
Specifications
for
→
Physical Network:
 Customer service
 Cost
 Flexibility
 Risk
In terms of customer service, the specification can be very clear: customer X should be provided with facilities A and B, be served within C hours, and so on.
In terms of cost, the specification could be a given margin for a given customer. However, the cost will most of the time be the criterion we want to minimize, the other
specifications acting more as constraints.
In terms of flexibility, the specification could be to keep the efficient operation of the system for a given increase or decrease of the volume
Under the term risk there can be many different specifications. The redesign of a logistics network is a major change. Every major change undergoes a series of risks like, for
example, brand image degradation, strikes, …)
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6.3. Data and Design Variables
Data: Amount of goods to be shipped (now and in the future)
The network should be able to bring the goods from the incoming point (the manufacturing) to the outgoing point (the customers or the next intermediary in the channel).
The amount of goods is thus the first data. The figure should be based on forecasts. We could imagine here several scenarios depending on the possible evolution of the
company. The figures should be detailed per product lines or per stock keeping unit if the processing of these goods is supposed to vary
The Origin and Destination of these goods
This is the second main data. Generally the destination point is determined by the location of the customer. The origin is determined by the manufacturing site. In some cases,
several manufacturing can provide the same goods.
Design variables:
Facilities:
types, number and location
Where do we want to have warehouses (or any other facilities) ?
Transportation: mode, routing
By which means will the goods be transported, and along which routes ?
Material flow:
production lot size, shipping lot size,
safety stock, inventory management
How many units of the same SKU will be manufactured and shipped at once ? Which inventory control will we use and with which parameters (lot size, safety stock) ?
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6.4. Audit the current network
The goal here is to get a clear picture of the current situation. There we need to get information in several areas.
 Current network: Facilities / Transportation / Material flow
We should clearly now how the network looks like today and how it is operated. We thus need the current values for all the design variables.
 Current practices in the company
Not only we need to know how the network is operated, but also what is the state of mind of its actors. This is vital in order to evaluate the “human” risk associated with the
possible changes that could be implemented.
 Current performance
Based on measurement that hopefully exists, we should estimate the performance reached with the current situation. In addition to obtaining the current performance, this step
should help us understanding how and why we have these figures.
Cost
A detailed activity based costing analysis will allow us to understand what are the cost centers, the cost drivers and the tariffs. We will detect for example the cost of storing
one unit of SKU, of processing one “customer order”, of shipping a full truck load over 1 kilometre, etc. These data will be necessary for the cost evaluation of new
solutions.
Customer service
The same can be done for customer service. Let us take for example the order cycle time, that is the time between the moment a customer places an order and the time he is
delivered. We will detect several operations in the process: order processing, order picking, order packing, order transportation, etc. In addition to the times needed for these
operations, wait times must de detected and measured. Again, all these figures will be needed for the evaluation of possible new alternatives.
Flexibility
Here too, the past experience will provide you with information about how flexible the system was or wasn’t and why.
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The internal audit and data collected from other existing network should allow you to determine accurate cost models. These models will be necessary to evaluate alternative
solutions. Here we propose a rough methodology for the cost evaluation of potential solutions
6.5. Cost Models
1. Determine the cost components of the network
Warehouse cost
Warehousing costs include fixed costs such as warehouse and maintenance facilities, material handling and other equipments. They also incorporate all the in-bound
operations (unloading, unpacking, inspection and shelving) which are proportional to the number of processed items. Warehousing costs don't include the holding cost of the
inventory.
Transportation cost
The transport costs are mainly a function of the transportation mode or combinations of modes (air, truck, rail or sea). They also depend on the volume or weight carried and
the final destination.
Inventory cost
Stored goods generate two kinds of costs: storage cost (deterioration, obsolescence, insurance) on the one hand and opportunity cost of the capital tied-up in inventory on the
other hand. Both costs are generally expressed as some percentage of the stored value. For example, a 20 percent rate means that storing goods for one million EUROs during
one year generates a cost of two hundred thousand EUROs.
The investment in stored goods is mainly influenced by the procurement lead time and by the quality of the demand forecast.
The performance of a company, in reference to inventory, is usually measured by the turnover ratio, which is calculated by dividing the cost of goods sold each year by the
average value of the inventory. The larger the turnover ratio is, the smaller the holding cost will be. However, this ratio is often determined globally, hiding differences
between parts
Order processing
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The administrative operations are either automated (on-line check/allocation/order) or performed by people. This could be considered a fixed cost per order or a fixed cost for
the distribution centre.
Order processing picking
The picking operations are labour intensive. The amount of work is mainly proportional to the number of lines processed.
Order processing packing
Packing is proportional to the number of orders processed and to a smaller extent to the number of lines.
Change cost
The cost incurred if the network is modified. Closing a warehouse or training people are such costs.
2. Rank these components and evaluate the main ones
The idea here is to determine some ranking in order to simplify the model. We could for example detect that the warehouse costs and the transportation are the main
contributors to the global bill.
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3. Determine a model for each relevant cost in terms of the
network design variables
The idea here is to derive a model that will allow to predict how the costs will evolve with the design variables.
Warehouse cost
The warehouse costs do vary with several variables: the number of SKUs, the number of inbound operations, the number of processed items. The number of items processed
daily is a good base.
Cost
of a
single
wareh
ouse
70
50
45
40
35
30
25
20
15
10
5
0
60
50
Total
wareh
ouse
cost
40
30
20
10
0
0
1
2
3
4
1
2
3
4
Volume processed daily
Number of warehouses
The idea is therefore to draw this cost curve that should have this concave shape for economy of scale reasons. We can then derive how the total warehouse cost would evolve
with respect to the number of warehouses.
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Transportation cost
The cost driver is definitely the distance travelled. The tariff varies with the transportation mode and with the lot size. We should for example get the cost for moving a full
truck load over a kilometre.
Since the number of warehouses is a design variable, a model that relates the transportation cost to this variable is useful. The curve has the following shape.
35
30
25
Total
transportation
Cost
20
15
10
5
0
1
2
3
4
5
6
Number of warehouses
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Let us try to explain this shape for a simple system where the goods are transferred from the manufacturing plant to a warehouse and then from the warehouse to the customer
(the reasoning remains the same for multi-echelon systems). First, we have to understand that whichever network structure we use, the goods have to be brought from the
manufacturing plant to the final users. This distance can be split in two parts: the distance from the plant to the warehouse and the distance from the warehouse to the
customer. Assuming we do not make detours, we have:
Dist (Pt →Ct) = Dist (Pt →Wh) + Dist (Wh →Ct)
Now, let us look at the transportation means that will be used. Warehouses with large volumes will be served from the manufacturing plants or from other warehouses by
means of a cheap transportation system such as boats or full trucks. The customers, however, order smaller quantities. They will thus be served from a neighbouring
warehouse using a more expensive transportation mean.
Cost (Pt →Wh) ≤ Cost (Wh →Ct)
As the number of warehouses increases, the total cost decreases.
As the number of warehouses ↑
Cost (Pt →Wh) Dist (Pt →Wh) + Cost (Wh →Ct) Dist (Wh →Ct) ↓
However, this does not remain true as the number of warehouses gets too large. Indeed, in this case, the volume dealt with by each warehouse gets smaller preventing the use
of a very cheap transportation mean for its supply.
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Inventory cost
We should distinguish between the different types of stocks: pipeline stocks, cycle stock and safety stock.
Pipeline stock = demand × Pipeline length
Pipeline stock is the inventory in transit (on boats, trucks, etc.). Since all the goods sold should go through the pipe, it is proportional to demand (in days) and to the length of
the pipeline expressed in the same unit (days).
Reducing this inventory means reducing the pipeline length (unless we want to sell less …). Two different network structures serving the same total demand with the same
pipeline length will thus lead to the same amount of pipeline stock.
Cycle stock = ½ Order lot size
The cycle stock is the average stock kept at each level because of lot sizes. If each time a warehouse orders some SKU, the order is placed for a full pallet, and if the
customers order the SKU unit per unit, the cycle stock will vary from a full pallet to zero. In this case, the cycle stock amounts to half a pallet on the average.
The order lot size is usually defined by economical order quantities. The formula is the following (see the chapter on inventory control) with OC and HC representing the
Order cost and the holding cost respectively.
Order lot size = SQRT ( 2 ×demand × OC / HC)
This means that if the demand dealt with by a warehouse decreases, then the cycle stock also decreases but less than not proportionally.
SQRT(K×(D1+D2)) ≤ SQRT(K×D1) + SQRT(K×D2)
A network with a smaller number of warehouses will result in a smaller total cycle stock.
25
20
Total Cycle
Stock
15
10
5
0
1
2
3
4
Number of warehouses
This explains the concave shape of the cyclic inventory.
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Safety stock = k σ
The safety stock is a stock that is kept in the warehouse to react to demand variation. It is proportional to some constant k that depends on the service level that is aimed at
and to the standard deviation of the demand. Since
σ (D1 + D2) < σ (D1) + σ (D2)
the total safety stock needed in a network decrease with this number of warehouses and we have a chart similar to that obtained for cycle stock.
25
20
15
Total Safety
Stock
10
5
0
1
2
3
4
Number of warehouses
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6.6. Other Models
The above approach should be used for the other performance.
Customer service models
Order cycle time
Product availability
Flexibility models
Risks models
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6.7. Analysis of alternative solutions
The approach we propose here is heuristic. It aims at organizing the analysis by separating the variables. This is sub-optimum but allows to keep the analysis tractable.
A. Heuristic approach
At each step, some solution are rejected based on the analysis performed at this level. Solutions are discarded because they do not meet the objectives, that is, the
specifications in terms of cost, of customer service, of flexibility or of risks. Only solutions that clearly violate some objectives should be rejected. All the others should be
kept one more step. At the next step, additional variables are taken into account. This allows the performance of the solution to be analysed in more details.
1. Select the structure (the graph) and the type of facilities:
The goal here is to select how could the network look like and how it will be operated.
Star / Multi-level hierarchical / Meshed
2. Select the cardinality:
How many facilities at each level
3. Select the location:
The geographical location of each facility
In an ideal approach, there should be a loop between these different steps. Here is an example. The selection of location could show that no feasible location exists in a
region. In this case, we could decide to reduce the number of warehouses and go back to the previous step.
In order to make choices, the performance should be evaluated at each step. Therefore the models proposed here should be used. The section on location methods provides
two different approaches for dealing with the selection of locations.
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B. Operation research approach
Global models that aim at optimising the network structure and the location problem at the same time can be designed. However, such models are extremely hard to solve for
real cases. Here below we give some of the reasons.
 O/1 Models
Since the number of levels in the network is a variable, the problem contains 0/1 decision variables
 Discrete models
The number of warehouses is a discrete variable
 Non linear function
The cost functions are non linear in the decision variables. We have for example seen that most cost functions are non linear.
 Concave function
Let us try to understand this statement intuitively. Assume we have a given network and we wonder if it would be effective to merge two warehouses. This merge could bring
some savings in terms of warehouse cost. However, this merge will most likely increase the transportation cost. In some cases, such a merge will not be globally cost
effective. However, if we would merge more than two warehouses, the savings in terms of warehouse cost will increase more than proportionally, leading to a solution that
could now be cost effective. In other words, we can have cases where a small variation is not cost effective (the merge of two warehouses) while larger variations (the merge
of several warehouses) is. This is the sign of a concave function.
→ NP-hard problem
All these features make the problem hard to solve. In terms of complexity, it can be shown that the problem is NP-hard.
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6.8. Facility Location
Here below we propose several techniques. The first technique focuses on the transportation costs only. It can be used to minimize either the delivery or the supply costs.
When such costs are high, it can be used to determine the best area for locating the plant or the shop.
The second technique is more general (and also more heuristic). It aims at ranking different solutions on the basis of qualitative and quantitative factors. This technique is
very useful to shorten the list of candidates.
Technique: 1. Transport cost minimization
The aim of this technique is to locate the plant (or the service outlet) in the "middle" of its customers. The technique proceeds as follows.
1. define where products have to be transported (ai,bi);
2. define how much (wi);
Mathematically, the problem can be formulated as follows:
3. Minimize: in1 wi
Over:
 x  ai 2   y  bi 2
( x, y)
This problem does not admit a simple algebraic solution. An iterative method is necessary for getting the solution.
3’ Compute the center of gravity (x,y) of {(ai,bi)};
Each position (ai,bi) has a weight (wi). The solution is thus the center of gravity of this set of points which could be computed by the following physical model. Take a solid
map. At each location: perforate the map, introduce a thread in the hole with a weight (wi) below the map. Tie all the threads together above the map. Hold the map and let all
the threads free. The center of gravity should be given by the position of the node.
Another approach consists in using the rectilinear distance:
3”
Minimize: in1 wi  x  ai  y  bi
Over:
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 w  w
i|a  x i i|a  x i
i
 i
Solution: the “median” 
 w  w
i|b  y i i|b  y i
 i
i
Let us first consider the case where all the weights are equal to 1. Let assume we have four locations with coordinates: (1,1), (3,5), (5,2) and (5,4). Then, the median of the x
values is any value in [3,5] and the median of the y values is [2,4]. This means that any point in the square (3,2), (3,4), (5,2), (5,4) will minimize the objective function. To
convince yourself compute the objective function for the solution (x,y)=(3,2). Then check which distances do change if we move the solution to (3,2+z). In fact, some
distances will increase by z and some will decrease by z. Since we are at the median, there are as many distances that increase as distances that decrease. Globally, the
objective function does not change. Similarly you can observe what happens if we leave the median region. In this case, the objective function increases. If a location has a
weight of let’s say 2, this is similar to having 2 sites with unit weight at the same location. The solution can be found in the same way. As an example, for the weights 3,4,2
and 2, the median is the point (5,2).
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Techniques: 2. Factor-rating systems
The factor-rating method aims at ranking different sites/choices for building a short list.
2.1.
determine factors

living conditions

population

transportation

supplies

taxes
First, you decide which factors are relevant. For this, it is again useful to consider the supply, the production and the delivery processes.
2.2.
weight factors
Then, relative weights must be given to these factors. These factors express your personal interest in the above factors.
2.3.
score each site on a same scale
This scoring is an absolute measure (that does take into account your personal interests). Once this objective scoring has been performed, you compute for each possible site,
the product of the scores by the weights and sum up the results to get the global score.
2.4.
select the site with the highest score
Here, to illustrate how the method works, we will consider the problem of choosing a study major (the subject in which you will take most of your courses). We assume that
you have the choice between 4 main subjects called H, F, M and P.
Example: Selecting your Major
It has been assumed that the relevant factors are those of the first column of the next table.
Factor
Weight
Score
Score
Score
Score
for H
for F
for M
for P
Personal Interest
2
9
7
8
5
Job opportunities
3
2
7
6
7
Amount of work
2
8
6
6
2
Success probab.
1
7
8
8
6
47
55
54
41
In this example, each factor has been rated on a same scale (between 0 and 10). Using the factors of column 2, the final score shows that the options M and F are worth
further evaluation.
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7. Bibliography
Askin, G. / Standridge, Charles R. (1993): Modeling and Analysis of Manufacturing Systems. John Wiley & Sons, Inc.
A.T.-Kearney (1993): Logistics Excellence in Europe. A. T. Kearney, Inc.
Bowersox, Donald J. / Closs, David J. (1996): Logistical Management -- The Integrated Supply Chain Process. The McGraw-Hill Companies, Inc.
Cohen, M.A. / Kleindorfer, P.R. / Lee, H.L. (1988): Service constrained (s,S) inventory systems with priority demand classes and lost sales. in Management Sci. Vol. 34
No. 4, 482-499
Cohen, M.A. / Lee, H.L. (1990): Out of touch with customer needs ? Spare parts and after sales service. Sloan Management Review, 55 Winter, 55-66
Coyle JJ, E.J. Bardi, C.J. Langley Jr., The management of Business Logistics, West Publishing Company, 6 th edition, 1996.
Christopher, M. e.a. (1979): Customer service and distribution strategy. Associated Business Press, London
Christopher, M.
(1985): The Strategy of Distribution Management. Gower Press, London
(1992a): Logistics and Supply Chain Management -- Strategies for Reducing Costs and Improving Services. Pitman Publishing, London
(1992b): Logistics - The strategic issues. Chapman & Hall, London
Cooper, R. / Kaplan, R.S. (1988): Measure Costs: Make the Rights Decisions. Harvard Business Review, septembre-octobre, 96-103
European Logistics Association (ELA) (1994): Terminology in Logistics - Terms and Definitions. 2d edition, Brussels
Johnson, H.T. / Kaplan R.S. (1987): Relevance Lost: The Rise and Fall of Management Accounting. Harvard Business School Press, Boston
Kumar, Anil / Sharman, Graham (1992): We love your product, but where is it? The McKinsey Quarterly, Number 1, 24-44
Lambin, Jean-Jacques (1993): Strategic Marketing -- A European Perspective. McGraw-Hill Book Company
Pfohl, H.-Chr. (Ed.) (1994): Future Developments in Logistics and the Resultant Consequences for Logistics Education and Training in Europe. Logistics Educators
Conference 1994. European Logistics Association, Brusssels
Ploos van Amstel, M.J. / Ploos van Amstel, W. (1987): Economic Trade-Offs in Physical Distribution - A pragmatic Approach. International Journal of Physical
Distribution and Materials Management, Volume 17, n° 7
Robeson, James F. (1985): The distribution handbook. The free press, Macmillan, Inc., New York
Sharman, G. (1989): What 1992 means for logistics. The Mc Kinsey Quarterly, Mc Kinsey & Company, New York, Spring
Shiba, Shoji / Graham, Alan / Walden, David (1993): A New American TQM -- Four Practical Revolutions In Management. Productivity Press/The Center For Quality
Management
Simmons, G. / D. Steeple (1991): Overhead Recovery - It's Easy as ABC. Focus: on Logistics and Distribution Management, October 1991, Volume 10 number 8, 24-27
Touche, Ross / Institute of Logistics (1995): European logistics comparative costs and practices. European Logistics Association. Brussels
Zeithaml, Valarie A. / Parasuraman, A. / Berry, Leonard L. (1990): Delivering Quality Service. The Free Press
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8. Case: Llenroc Plastics Europe
Description:
 Company background
 Company problems
 Assignments
Documents
 Students notes
 Teaching notes
 Slides
 Software
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