Network Design
McGraw-Hill/Irwin
Copyright © 2010 by The McGraw-Hill Companies, Inc. All rights reserved.
Network design overview
• Enterprise facility network
• Warehouse requirements
• Systems concept and
analysis
• Total cost integration
• Formulating logistical
strategy
13-2
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
13-3
Spectrum of location decisions exists but chapter
focus is on selecting warehouse locations
• Transportation services link
locations into an integrated
logistical system
• Selection of individual locations
represents competitive and
cost-related logistical decisions
– Manufacturing plant locations
may require several years to fully
deploy
– Warehouses can be arranged to
use only during specified times
– Retail locations are influenced by
marketing and competitive
conditions
13-4
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
13-5
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
13-6
Procurement drivers help purchase materials and
components at the lowest total inbound cost
• Limited number of deeper relationships with suppliers
• Life cycle considerations
– E.g. material purchase, reclamation, and disposal of unused materials
• Debundling of value-added services leading to new structural
relationships with suppliers
• Seasonality of selected supplies
• Opportunities to purchase at reduced prices
• Rapid accommodation of manufacturing spikes
• Facilities placing more emphasis on sorting and sequencing
materials
13-7
Manufacturing drivers help consolidate finished
product for outbound customer shipment
• Provide customers full-line product assortment on a single
invoice at truckload transportation rates
• Choice of manufacturing strategy is primary driver
– Make to plan (MTP)
• Requires substantial demand facing warehousing
– Make to order (MTO)
• Requires supply facing support, but little demand warehousing
– Assemble to order (ATO)
13-8
Customer accommodation drivers provide custom
inventory assortments to wholesalers/retailers
• Maximize consolidation and length of haul from plants
• Rapid replenishment from wholesalers
– E.g. food and mass merchandise industries
• Market-based ATO situations using decentralized
warehouses
• Size of market served by warehouse based on
–
–
–
–
Number of suppliers
Desired service speed
Size of average order
Cost per unit of local delivery
13-9
Warehouse justification is based on providing a
service or cost advantage from their location
• Must achieve freight
consolidation with
warehouse positioning
– Inventory storage to
support customized orders
– Mixing facilities to support
flow-through and crossdock sorting
13-10
Key design questions to ask when
developing a logistics network
• How many and what kinds of
warehouses should a firm
establish?
• Where should they be located?
• What services should they
provide?
• What inventories should they
stock?
• Which customers should they
service?
13-11
The “Systems” Concept
• Systems concept is an analytical framework that
seeks total integration of components essential to
achieving stated objectives
• Components of logistical system are its functions
–
–
–
–
–
–
Order processing
Inventory
Transportation
Warehousing
Materials handling and packaging
Facility network design
13-12
Systems analysis seeks to quantify trade-offs
between logistics functions
• Goal of system analysis is to create an integrated effort (i.e.
a whole) which is greater than its individual parts
• Goal from a process perspective is balanced performance
between functional areas both within the enterprise and
across its supply chain
• Functional excellence is the contribution a function makes
to the success of the overall system (or process)
• Focus of system analysis is on interactions (i.e.
relationships) between components
13-13
Principles of general systems theory
• Total system performance is singularly important
• Individual components don’t need to be optimized
– Emphasis is on the integrated relationship between components
• A functional relationship exists between components called
a trade-off
– May enhance or hinder total system performance
• Components linked together in a balanced system will
produce greater end results than possible through
individual performance
13-14
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
13-15
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
13-16
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
• Network transportation cost minimization
13-17
Example of cost-based warehouse justification
using transportation consolidation
• Assumptions
– Average shipment = 500
lbs
– Freight rate to customer =
$7.28 per cwt
– Volume transport rate =
$2.40 per cwt
• For shipments 20,000+ lbs
– Local delivery within market
= $1.35 per cwt
• Options
– Direct ship to customer =
$36.40 per average
shipment
– Ship to market at volume
rate and distribute locally
• Total rate = $3.75 per cwt
• $18.75 per average shipment
• Can you justify the use of
a warehouse in this
situation?
13-18
Network transportation cost minimization
Figure 13.2 Transportation Cost as a Function of the Number of
Warehouse Locations
13-19
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
13-20
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?
13-21
Additional warehouses typically reduce total
in-transit inventory
Figure 13.3 Logistical Network: Two Markets,
One Warehouse
Table 13.1 Transit Inventory under Different Logistical Networks
Figure 13.4 Logistical Network: Two Markets,
Two Warehouses
Results
13-22
What about the impact on safety stock?
• Safety stock is needed to protect against unplanned
stockouts during inventory replenishment
• Uncertainty in network is impacted by adding warehouses
– Performance cycle days are reduced
– Number of performance cycles increases
• Prevents aggregation of uncertainty across market areas
• Serving the same market area by adding warehouses will
increase uncertainty since each facility has its own
replenishment cycle
– Therefore, more safety stock is needed
13-23
Combining demand into one warehouse
averages demand variability
Table 13.4 Summary of Sales in One Combined and Three Separate Markets
More safety stock is required if markets
served from ‘local’ warehouse
13-24
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
13-25
Network inventory cost minimization
Figure 13.5 Average Inventory as a Function of Number of Warehouse Locations
13-26
Total cost of the network is illustrated in
Figure 13.6
• 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
13-27
Illustration of total cost concept for the
overall logistical system
Figure 13.6 Least-Total-Cost Network
13-28
Assumptions are important to understand for their
impact on finalizing a strategy
• Analysis summarized in Figure 13.6 does not
include all relevant costs
– Projected sales based on a single planning period
– Transportation costs based on a single average-size
shipment
– Desired inventory availability and fill rate assumptions
impact the solution
13-29
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
13-30
Visualization of solution adding variables
shipment size, transportation mode and location
Figure 13.7 Three-Dimensional Total Cost Curve
13-31
Formulating logistical strategy requires evaluating
alternative customer service levels and costs
• General approach to finalizing a logistical strategy
– Determine a least-total-cost network
– Measure service availability and capability for this
network
– Conduct sensitivity analysis for incremental service
options
• Use cost and revenue associated with each option
– Finalize the plan
13-32
Threshold service level is customer service
associated with the least-total-cost-system
• Existing policies of availability and capability are often
assumed as the threshold service level
– Current performance provides starting point for potential service
improvements
• Result of a customer service availability analysis is shown
in Figure 13.8 for warehouses X, Y and Z
– Based on distribution of an average order
– Delivery time is estimated on the basis of distance
– Transit inventory estimated based on delivery time
• Management can make basic customer delivery
commitments of the basic service platform
– Use an estimate of expected order cycle time
13-33
Illustration of total logistics cost for three
warehouse locations
Figure 13.8 Determination of Service Territories: Three-Point, Least-Cost System
13-34
Service sensitivity analysis uses the threshold
service level to evaluate potential changes
• Basic service capabilities of a network change with
variations in
– Number of warehouses
• Adding warehouses increases fixed costs
– Performance cycles
• E.g. web-based ordering, premium transportation
• Typically increases variable costs
– Safety stock policy
• Increase in SS will shift average inventory cost curve upward
13-35
Variations in the number of warehouse locations
is illustrated in Table 13.5 in the text
• Key points from this table
– Incremental service is a diminishing function
– High degrees of service are achieved much faster for longer
performance intervals than for shorter intervals
– Total cost increases dramatically with each location added to the
logistical network
• Portfolio effect is the relationship between uncertainty and
required inventory
• Portfolio effect can be estimate using the square root rule
13-36
Finalizing strategy requires evaluating the
incremental service cost vs. incremental revenue
• Figure 13.9 illustrates an example
– Marketing proposes
• 2% improvement in inventory availability
• 36-hour improvement in delivery capability
– Design analysis determines a 12 warehouse lowest-cost network
is needed
• Incremental total cost to achieve proposed option = $400k
per year
• Incremental revenue needed to break even = $4million per
year
– Assumes 10% profit margin
13-37
Figure 13-9 Comparative Total Cost for 5and 12- Distribution Point Systems
Figure 13.9 Comparative Total Cost for 5- and 12- Distribution-Point Systems
13-38