13

Network Designing

As the trend to outsourcing continues to grow, so too does the complexity of the supply/demand network

 

 

—Anne Mulcahy¹

INTRODUCTION

Supply Chain Management (SCM) is the process of planning, implementing and controlling the operations of the supply chain efficiently. SCM spans all movements and storage of raw materials, work-in-process inventory, and finished goods from the point-of-origin to the point-of-consumption. Part of the planning processes in SCM aim at finding the best possible supply chain configuration so that all operations can be performed in an efficient way. This covers integrating facility location with other important functions of the supply chain such as procurement, production, inventory, distribution and routing.

In supply chain planning is done at three levels depending on the time horizon: strategic, tactical and operational. The strategic level deals with decisions that have a long-lasting effect on the firm. These include decisions regarding the number, location and capacities of warehouses and manufacturing plants, or the flow of material through the logistics network.

The terms ’network design’ and ‘supply chain network design’ (SCND) are often considered synonymous of strategic supply chain planning. Although typically no location decisions are made on the tactical or even operational level, a number of issues are strongly related to them such as inventory control policies, the choice of transportation modes and capacities, warehouse layout and management, and vehicle routing. In today's competitive market, a company's distribution network must meet service goals at the lowest possible cost. In some instances, a company may be able to save millions of rupees in logistics costs and simultaneously improve service levels by redesigning its distribution network. To achieve this, an ideal network must have the optimum number, size, and location of warehouses to support the inventory replenishment activities of its distributor/retailers. This requires proper facility location models to determine the best supply chain configuration which underlines the interrelation between the strategic and the tactical/operational planning levels.

ROLE OF NETWORK DESIGN

Designing a supply chain network provides the basic structure for supply chain operations. The network is a major element in a firm's competitiveness and a significant area of capital investment. Network design focuses on the process, location and capacity aspects of a supply chain. This covers location of production and warehousing facilities to best meet customer demand at the right locations. Not only determining of location is included in network design analysis, but also the replenishment linkages from a facility to its downstream supply chain partners are covered.

SCND normally utilizes optimization technology, which develops least cost network efficiently. An optimization model can be constrained by capacity limitations on facilities, and also by limiting the length/time of replenishment sources. This addresses time-based aspects of a supply chain based on distance between the point of demand and the point of supply. However, this type of constraint is a representation of lead time and many other factors beyond just distance, which contribute to the ability of facility to fulfil the product/service demand.

The optimization technology on network design solution is capable of effectively selecting a suitable supply chain structure from amongst thousands of options. The macro nature of this analysis is best suited to work on structural and location problems.

The role of facility decisions in a supply chain includes the location of manufacturing, storage, or transportation-related facilities and the allocation of capacity and roles to each facility. Facility decisions are classified as indicated in Exhibit 13.1.

 

Exhibit 13.1 Classification of Facility Decisions

Facility role	Processes performed by each facility
Facility location	Facilities location sites (region/country/FTZ)
Capacity allocation	Capacity allocated to each facility
Market allocation	Markets each facility serve

All network designs are interrelated; any decisions made will affect each other. Therefore a decision must be made taking this fact into consideration. Decisions regarding the role of each facility are of significant importance because they determine the amount of flexibility the supply chain has in meeting the demand.

Facility location decisions have a long-term impact on a supply chain's performance. It is very expensive to shut down a facility or move it to a different location. Hence, organizations must live with their location decisions for a long time (decades). A good location decision can help a supply chain be responsive while keeping its costs low. Toyota, built its assembly plant in the United States in 1988. This plant proved very profitable for Toyota when the yen strengthened and cars produced in Japan were too expensive to be cost competitive with cars produced in the United States. The plant allowed Toyota to be responsive to the U.S. market while keeping costs low.

A poorly located facility makes it very difficult for a supply chain to be efficient. It is very difficult to be responsive and cost-effective too. Capacity allocation decisions also have a significant impact on supply chain performance. Capacity allocation to the facilities can be altered more easily than location. But, capacity decisions do tend to stay in place for several years. Allocation to a large capacity to a plant for location markets with less demand, results in poor capacity utilization and hence higher costs. Alternatively, too little capacity results in poor responsiveness if demand is not satisfied.

The allocation of supply sources and markets to facilities has a significant impact on performance because it affects total production, inventory, and transportation costs incurred by the supply chain to satisfy customer demand. This decision should be reconsidered on a regular basis so that the allocation can be changed as market conditions or plant capacities change. For example, a company has grown its customer base, the company has built new warehouses and changed the markets supplied by each warehouse. As a result, company will lower the costs and improve the responsiveness. The allocation of markets and supply sources can be changed only if the facilities are flexible enough to serve different markets and receive supply from different sources.

Decisions on network design have a significant impact on performance because they determine the supply chain configuration and set constraints within which inventory, transportation, and information can be used to either decrease supply chain cost or increase responsiveness. A company has to focus on network design decisions as its demand grows. Then its current configuration may not prove cost-effective and will exhibit poor responsiveness. For example, in India majority of pharmaceutical companies outsource their manufacturing to local vendors to serve local markets divided into zones. This arrangement is cost-effective from logistics point of view.

Network design decisions are also very important when two companies merge. Because the markets served by the combined firms are different from those served by either of the two separate firms. In mergers, consolidating some facilities and changing the location and role of others can help reduce cost and improve responsiveness.

STRATEGIC FACTORS IN NETWORK DECISION

A decision on the SCND is greatly influenced by the competitive strategy in service offerings to the customers. A company opting for cost leadership will decide on the lowest cost location for their manufacturing facilities. This may reduce the level of responsiveness of the firm. However, firms focusing on responsiveness will locate facilities near to the demand points. This may increase the cost location.

When designing a supply chain network the strategic factors such as speed to market, economic factors, infrastructure and network size are very important in determining a network that will deliver the desired level of customer service. However, achieving a trade-offs among these factors properly is the key to getting it right. Similarly, when designing a logistics network, strategic factors (Figure 13.3) such as speed to market, cost effectiveness and system effectiveness are important in determining a network that will deliver the intended level of customer service. Managing the trade-offs among these factors is the key to effectiveness of overall business.

• Speed-to-market: The term ‘speed-to-market’ mostly applies to how fast a company can create and launch a new product or service. Speed to market is how quickly a company can differentiate itself by providing an innovative or value-added product for a targeted customer segment. A major benefit is increased profitability through greater efficiency in revenue.
• Cost-effectiveness: As the number of facilities increase, facility costs, inventory costs and transportation costs will increase. Thus, these trade-offs must be analysed in order to arrive at a best solution. Sometimes near to the market doesn't mean the facility is system effective. Outsourcing is the one option available but economic factors such as taxes and exchange rates play a pivotal role in the location design decision. As a thumb rule, the following needs to be looked into before locating a facility on cost consideration:
  • Inventory cost increases with increase in number of facilities.
  • Facility cost increases with increase in facilities.
  • Transportation cost increases with increase in number of facilities.

Cost-effectiveness also very much depends on the choice of available production technology, which has a significant impact on network design decisions. With new technology, if economies of scale are possible to achieve, a few large capacity plants are more cost-effective. In many cases such as soft drinks bottling, a local production facility with lower fixed cost is preferred to reduce the transportation costs. The distribution cost of soft drink increases exponentially, if distribution is done beyond 120 kilometres. To reduce transportation costs, Coca-Cola/Pepsi have set up many bottling plants each serving its local market. In India, each one of them has 40–45 bottling plants located across in almost all states.

 

 

The lack of flexibility in production technology prompts the company to set up separate facility for each market. In such case, a firm has to set up local facilities to serve the market in each country. On the contrary, with flexible technology, manufacturing in a few large facilities is possible with significant cost-effectiveness.

• System effectiveness: Access to all the important variables such as man, machines, and materials is essential to work supply chain system effectively. Services such as water/drainage, consistent supply of electricity and the quality and proximity to main transportation routes are vital.

OPERATIONAL AND TACTICAL FACTORS

These factors have a major impact on network design decisions.

• Market reach: As a thumb rule, in supply chain the supply points should be near to the demand points. If the speed to the market (availability of product in FMCG industry) is a differentiator, then outsourcing production to the vendors near to demand points will be a prudent decision. Many organizations outsource production to low-cost regions/countries to have a competitive advantage, but it's important to consider what impact that has on customer service levels. If an organization is following a low-cost strategy, it makes sense to source where it is most cost-effective and undermining the speed to market, that is, sourcing facilities in close proximity to the consumer market would be a better strategy.
• Product type: The type or nature of product will decide the number of warehouses. FMCG products are purchased in small quantities and frequently for daily consumptions. Hence, to address the availability, large number of warehouses are required near the demand points (retailers). On the other hand, the customer is ready to wait for engineering products which are not frequently purchased. Here, the warehouses are limited in numbers located in metros/factory areas. The other example is perishable products. The cold warehouses are located near the consumption centres and also at the place of production to keep the product (vegetable/fruits) in good condition before they are transported to the markets.

• Regulations: It is mandatory to follow the warehouse location regulations for certain products like explosives, hazardous chemicals and radioactive materials which can cause damage to human life. These facilities are located quite away from human habitation and outside municipal limits of cities/towns.
• Political factors: The political stability of the country under consideration plays a significant role in the location choice. Countries with independent and clear legal systems allow firms to feel that they have recourse in the courts should they need it. This makes it easier for companies to invest in facilities in these countries.
• Tariff and tax incentives: The factors such as taxes and exchange rates play an important role in the network (facility location) design decision. In cross-country trade, exchange rates are of prime concern for any company doing business overseas. Placing the facility in tax-free zone (FTZ) will be an added advantage to overcome fluctuations in tax rates. Many countries also offer tax incentives. Wherein, companies do not have to pay taxes for 10 years in an effort to attract them to invest in their country. In India, many states are offering tax exemptions or concession taxes (excise duty or sales tax) over a period of 5–10 years, if manufacturing facility is placed in the tax-free zone.
• Infrastructure: The availability of amenities like water, electricity and drainage comes under infrastructure. This must also be taken into account while choosing the facility location. For raw material and finished goods movement, quality and proximity to main transportation routes are vital. The availability of skilled labour is also an important factor. They will have a major impact on the cost.
• Network size and logistics costs: The inventory cost and administrative costs are directly proportional to the number of facilities (Figure 13.4). However, the secondary transportation costs will decrease. Hence, trade-offs must be analysed in order to arrive at the best solution. Once the solution is reached, it is also necessary to determine suitable sizing of the facilities.
• Transportation costs: Transportation is the most visible element of logistics operation. It forms a link between supply chain networking components. It has a significant share in the overall cost of the firm and needs a great deal of planning to control it. The choice of transportation from the available modes such as air, rail, road and sea is most important to optimize the cost. The selection of transportation mode depends upon several factors. The manufacturer decides upon the transportation mode by taking into consideration the following criteria: speed, frequency, availability of service, reliability, consistency in delivery, capability and finally the cost.

 

Warehousing

Warehousing is an important switching facility in the supply chain network. It will facilitate a smooth speedy distribution. Hence, an important step in supply chain network design is deciding on the centralized or decentralized distribution system. The field distribution centre/warehouse can act as a mother feeding/replenishing facility to the demand points. Centralized distribution ensures tight control on inventories and can operate on economies of scale, resulting in lower operating cost. However, decentralized warehouse operations, with multiple distribution centres, ensures speedier services to customers. Product availability can be greatly enhanced by locating the warehouse near the market. With this arrangement, smaller and frequent deliveries, which customers prefer nowadays, can be organized. This will enhance customer confidence in the supplier. However, transportation cost, which is the major element in logistics cost, depends on the location of the warehouse. For planning a chain of warehouses, the management will have to undertake a cost-benefit analysis. The factors influencing decisions in planning an optimum number of warehouses are:

• Size of the market
• Nature of demand (seasonal/continuous)
• Product type
• Level of customer service
• Intensity of competition
• Establishment and operating cost

Site selection for a warehouse is an important step in network design. It can affect the overall costs of the operations impacting the margins. Thus site selection is a critical step. Following are the techniques which will help in selecting the site in a scientific way.

Single depot selection The distribution system of the firm normally consists of multiple warehouses located at various places. However, the location of a depot for a particular geographical area is decided using the following principles:

• Centre of gravity of area model: A map of marketing areas may be drawn and the sheet representing the area may be balanced. The centre of balance is the site for warehouse location. This point is expected to be at a minimum average distance from all locations in the area.
• Centre of gravity of load model: This may be illustrated visually by imagining a sheet having holes representing customer locations and their demand load of annual purchases. A weight, in proportion to the demand load, is hung at each hole. The point at which the model sheet is balanced gives the centre of weights. This is the proposed site where the warehouse can be located.
• Centre of gravity of tonnes—kilometres model: This model takes into consideration both load and distance to arrive at the optimum transportation cost. The final solution is arrived at through a trial and error method.

Multiple depot network    As a thumb rule, the cost of storage per unit of inventory is directly proportional to the number of warehouses. If the total sales is divided into more warehouses, the sales handled by each individual warehouse decreases and warehousing cost per unit sold increases. The increased cost can be offset by increasing sales per warehouse or decreasing number of warehouses.

STEPS IN NETWORK DESIGN PROCESS

The goal while designing supply chain network is to maximize the firms’ profits while satisfying customer needs in terms of demand and supply. To design an effective network a manager must consider all the factors described above. The framework of supply chain network consists of the following seven phases:

• Phase I: Define the network objectives.
• Phase II: Define a firm's broad supply chain design.
• Phase III: Evolve a supply chain strategy (based on competition, internal constraints, capital and growth Strategy).
• Phase IV: Define the regional facility configuration.
• Phase V: Identify facilities locations and their potential roles and capacities.
• Phase VI: Select a set of potential and desirable sites.
• Phase VII: Select a precise location and capacity allocation for each facility.

Attention is restricted to the desirable potential sights selected in phase 3. The network is designed to maximize total profits taking into account the expected margins and demand in each market, various logistics and facility cost and the taxes and tariffs at each location.

FACILITY LOCATION AND CAPACITY ALLOCATION

Whatever the situation, the ultimate aim of network design is to maximize the profits while satisfying customer needs. The following information ideally should be available in making the design decisions:

• Location of supply points (sources)
• Location of demand points (markets)
• Site location of potential manufacturing facility
• Market potential and demand forecast
• Capital and operating cost of facility
• Freight (inbound and outbound logistics)
• Inventory costs by site
• Sale price realization
• Taxes and tariffs
• Desired response time and other service factors

Different models are used during different phases of network design framework. These are as follows:

• Network optimization models: This pertains to decisions regarding which regions should be chosen to locate the facilities. The major factors to be considered by a manager are: regional demand, tariffs, economies of scale and aggregate cost factors. One of the network optimization models used is ‘the capacitated plant location model’.

The capacitated plant location network optimization model requires the following inputs:

• Number of potential plant locations with their capacities
• Number of markets or demand points
• Annual demand from assigned market
• Potential capacity of plant
• Annualized fixed cost of keeping assigned factory open
• Cost of producing and shipping from assigned factory and market

The following ’decision variables’ are defined:

• Plant is open or otherwise full
• Quantity shipped from assigned plant to market

The model is solved using and Excel sheet with all the requisite data. The model can also be modified to account for strategic imperatives that require locating a plant in some other region. This can be done by restricting one plant to be located in a particular region.

Network optimization models are also used for deciding on the location and the capacity allocation for each facility. Besides this, the manager also has to decide how the markets are allocated to facilities. This allocation must account for customer service constraints in terms of response time. Both location and allocation decisions are made jointly.

The problem of selecting the optimal location and capacity allocation is very similar to the regional network configuration problem. The only difference is location-specific costs and duties. In some cases, the company designs a supply chain network to serve separate market with one single factory/source. The rationale behind this is to minimize the complexity of coordinating the network and reduce flexibility from each facility. However, to achieve the capacitated plant location the model needs modification.

In cases where plants and warehouses are to be located simultaneously in the entire supply chain network from the supplier to the customer, a general form of the plant location model needs to be considered. In general, companies consider a model in which location and capacity allocation decisions have to be made for both factories and warehouses at the same time.

This model assumes that one unit of input from the supply source produces one unit of finished product. The model requires the following inputs:

• Number of demand points
• Number of potential factory locations
• Number of suppliers
• Number of warehouse locations
• Annual demand
• Potential capacity of factory
• Supply chain at suppliers
• Potential warehouse capacity at site
• Cost of locating a plant at desired site
• Fixed cost of locating a warehouse at desired site
• Shipping cost from different factories to warehouses to markets

The goal is to identify the plant and warehouse location as well as the quantities shipped between various points that minimize the total fixed and variable cost. The following decision variables need to be defined:

• If factory is located at a desired site or otherwise
• If warehouse is located at desired site or otherwise
• Quantity shipped from factories to warehouses to markets

Gravity Location Models

Gravity location models are very useful as they can be used to identify suitable geographic locations within a region. These models are used to minimize the cost of transporting raw materials from suppliers and finished goods to the markets. Gravity models assume that both the markets and the supply sources can be located as grid points on a plane. All distances are calculated as per the geometric distance between two points on the plane. This model also assumes that the transportation cost grows linearly with the quantity shipped.

The basic inputs required for the model are as follows:

• Coordinated location of either a particular market or supply source.
• Shipping cost for one unit for unit distance between the facility and market.
• Quantity to be shipped between facility, warehouse and market.

The equation can be solved using an Excel sheet provided the requisite information for the model is available.

NETWORK DESIGN DECISION ISSUES

With the passage of time, environmental factors change continuously; the demand changes too. With technological evolution, demand for old generation products disappears and finally the company's product mix changes. Each facility has its own working culture. The employees have typical way to work and exhibit their capability and capacity. In addition, quality differentials may be observed across the facilities. Hence, while deciding on a supply chain network, the following factors need to be kept in mind by the management.

Facility's Life Span

Facilities last a longer time and have an impact on a firm's performance. Therefore, it is very important that long-term consequences are considered when making facility decisions. The demand, costs and technology may change in future. Failure to take a note of these changing factors makes the facilities useless within a few years and become a financial burden to the firm.

Within most supply chains, production facilities are harder to change than storage facilities. Supply chain network designers must consider that any factory that they put in place will stay there for an extended period of a decade or more. Warehouses or storage facilities, particularly those that are not owned by the company, can be changed within a year of making the decision.

Cultural

Network design decisions regarding facility location and facility role have a significant impact on the culture of each facility and the firm. The culture at a facility will be influenced by other facilities in its vicinity. Network designers can use this fact to influence the role of the new facility and the focus of the people working there. A new facility in industrial area with unionized workforce will often have to face labour problems.

The location of a facility has a significant impact on the extent and form of communication that develops in the supply chain network. Locating a facility far away from headquarters will likely give it more of a culture of autonomy. This may be beneficial if a firm is starting a new division that needs to function in a manner different from the rest of the company. In contrast, locating two facilities closer together is likely to encourage communication between them. Extensive communication can be very useful if decision made at either facility have a strong impact on the performance of the other facility.

Quality of Life

The quality of life at a selected facility location has a significant impact on performance because it influences the workforce and their morale. In many instances, a firm may be better of selecting a higher cost location if it provides a much better quality of life. Failure to do so can have dire consequences. For example, an aerospace supplier decided to relocate to an entire newly area with a lower standard of living to reduce costs and most of the marketing team, however, refused to relocate. As a result, customer relation deteriorated and the company had a very difficult transition. The effort to save costs hurt the company and effectively curtailed firm's status as a major player in its market.

Tariffs and Tax Incentives

Facility location decisions should carefully be done on tariffs and tax incentives. When considering international locations, it is amazing how often tax incentives drive at the choice of location, often overcoming all of the other cost factors combined. For instance, Ireland has developed large high-tech industry by enticing companies with their low taxes to locate their European facilities there. Even within nations, local governments may offer generous packages of low to no taxes and free land when firms decide to locate facility within their jurisdiction. Leading pharmaceutical companies in India have their manufacturing facility in Baddi (Himachal Pradesh), to avail of the tax incentives offered by the state government.

DISTRIBUTION NETWORK DESIGN

Distribution refers to the steps taken to move and store a product from the supplier stage to a customer stage in the supply chain. Distribution occurs at every pair of stages in a supply chain. Raw materials and components are moved from suppliers to manufacturers, whereas finished products are moved from the manufacturer to the end customer. Distribution is the key driver of the overall profitability of a firm because it directly impacts both the supply chain cost and the customer experience.

Although, customer service consists of many components, measures that are influenced by the structure of distribution network include the following:

 

Exhibit 13.2 Delivery Performance-Related Network

Retail storage with customer pickup	Response time, order visibility, information, returnability, speedier transportation
Manufacturer storage with direct shipping	Product variety, product availability, inventory
Manufacturing storage with in-transit merge	Product variety, product availability, inventory
Manufacturing storage with pickup	Product variety, product availability, inventory, speedier transportation

• Response time is the time between when a customer places an order and receives delivery.
• Products variety is the number of different products/configuration that a customer desires from the network.
• Availability is the probability of having a product in stock when a customer order arrives.
• Customer experience includes ease with which the customer can place and receive their orders.
• Order visibility is the ability of the customer to track their order from placement to delivery.
• Returnability is the ease with which a customer can return unsatisfactory merchandise and the ability of the network to handle such returns.

A distribution network design needs to consider product characteristics as well as network requirements when deciding on the appropriate reliable delivery. The various networks considered earlier have different strengths and weaknesses. In Exhibit 13.2, the various delivery networks are ranked relative to each other along with different performance dimensions. A ranking indicates the best performance along a given dimension; as the relative performance worsens, the ranking gets higher. Only few companies will end up using a single distribution network. Most companies are best served by a combination of delivery networks. The combination used will depend on product characteristics as well as the strategic position that the firm is targeting.

• Response time
• Product variety
• Product availability
• Customer expectations
• Inventory cost
• Transportation
• Information

SUPPLY CHAIN MERGER

It is known that profitable growth is influenced by the size, function, and location of their manufacturing and distribution facilities. Even the technology for designing supply chain networks has been around since the early 1980s, when such tools were basically spreadsheets linked to inputs on a map.

But today's business world is altogether different than it was two decades ago. Faced with a more fluid, complex, global, and unpredictable environment, companies must reassess the composition, structure, and mission of their supply chain networks with greater diligence and frequency. And while many business changes legitimately warrant a reassessment of a supply chain network, the need to revisit and redesign that network is particularly critical when an organization goes for merger or acquisition.

Supply chain economies are usually the largest source of savings following a merger, acquisition, or sale of a division or business unit. However, most merged companies shortchange themselves by performing their network (re)designs only at a high level, and only during the post-merger integration process. One exception is a European manufacturer that purchased six companies in 10 years. As part of each acquisition, the company conducted a supply chain-network analysis that revealed new opportunities to:

• Curtail redundancy
• Increase delivery density
• Improve service by rationalizing deliveries within and across regions
• Cut travel times and increase truckload utilization
• Rationalize inventories
• Streamline order management and fulfilment
• Combine inbound flows and renegotiate supplier contracts
• Raise quantities of economic orders

The important network design questions in supply chain mergers are as follows:

• Suppliers sourcing and purchasing -Which, what and how much?
• Manufacturing
• -Where, what and how much?
• Transportation -DC locations
• Customer service
• -Responsiveness, flexibility and error recovery
• Channel network
• -Numbers, capacity and location

In mergers, the management mainly focuses on the financial and cultural aspects. In many cases, they fail to perform detailed supply chain network analyses of the merged company. Then they face the risk of going forward with duplication of processes, incompatible processes, higher inventory levels and higher cost of customer service. In such cases, customers do not view the organization as a unified business as they do not get uniform responses as in a single company.

REVIEW QUESTIONS

1. What is the role of network design in supply chain?
2. Discuss the various factors influencing network design.
3. Explain the framework for network design decisions.
4. In mergers, what are the network optimization issues?

INTERNET EXERCISE

1. Supply chain consultants (SCC) delivers strategic business solutions that enable clients in collecting, processing and sharing information across the supply chain network, visit http://www.supplychain.com/ and study some of the network solution they have offered.

VIDEO LINKS

1. Network Design—How it can help you, http://www.logisticsbureau.com.au/video-supply-chain-logistics.htm.
2. Warehousing and distribution network, http://www.logisticsbureau.com.au/video-supply-chain-logistics.htm.

PROJECT ASSIGNMENT

1. Ambuja Cements Ltd. have lowest logistics cost and wider market reach amongst all the cement manufacturing companies in India. Study their supply chain network and their distribution strategy, which is largely contributing to their cost leadership.