Chapter 3

1. Chapter 3 Network Planning

2. 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?

3. 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

4. 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 system-wide cost subject to a variety of service level requirements

5. 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

6. 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

7. 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.

8. 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

9. 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

10. 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

11. 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

12. Number of Warehouses Optimal Number of Warehouses

13. 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.

14. Unit Distribution Costs Two heuristics and an optimization technique: Choose the cheapest warehouse to source demand Choose the warehouse where the total delivery costs to and from the warehouse are the lowest LP

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

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 D = 50,000 $3 P1 to WH1 $3 P1 to WH2 $7 P2 to WH1 $7 P2 to WH 2 $4 $4 $2 $5 $5 D = 100,000 P1 to WH1 $4 P1 to WH2 $6 P2 to WH1 $8 P2 to WH 2 $3 $4 $1 $2 Cap = 60,000 D = 50,000 $2 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

17. 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 $3 P1 to WH2 $7 P2 to WH1 $7 P2 to WH 2 $4 $5 x 90,000 D = 100,000 P1 to WH1 $4 P1 to WH2 $6 P2 to WH1 $8 P2 to WH 2 $3 $1 x 100,000 $2 x 60,000 Cap = 60,000 D = 50,000 $2 x 50,000 P1 to WH1 $5 P1 to WH2 $7 P2 to WH1 $9 P2 to WH 2 $4 Total Cost = $920,000

18. 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

19. 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.

20. Optimal Solution Total cost for the optimal strategy is $740,000 *Your text has the w2c3 and w1c3 numbers reversed

21. DSS for Network Design • Flexibility to incorporate a large set of preexisting network characteristics • Other Factors: • 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

22. 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?

23. 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. • Net Lead Time = SI + T - S • Safety stock at the facility:

24. 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.

25. 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

26. 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%

27. Notations Used FIGURE 3-11: How to read the diagrams

28. 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.

29. Current Safety Stock Location FIGURE 3-12: Current safety stock location

30. Optimized Safety Stock Location FIGURE 3-13: Optimized safety stock

31. Current Safety Stock with Lesser Lead Time FIGURE 3-14: Optimized safety stock with reduced lead time

32. Supply Chain with More Complex Product Structure FIGURE 3-15: Current supply chain

33. Optimized Supply Chain with More Complex Product Structure FIGURE 3-16: Optimized supply chain

34. 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.

35. Local vs. Global Optimization FIGURE 3-17: Trade-off between quoted lead time and safety stock

36. 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.

37. 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

38. 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?

39. Integrating Inventory Positioning and Network Design FIGURE 3-18: Sample plot of each SKU by volume and demand

40. Three Different Product Categories • High variability - low volume products • Low variability - high volume products, and • Low variability - low volume products.

41. 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.