Chapter- 3

Supply Chain Network Design and

Optimization
 Supply Chain Network Design
What is it?
 Supply Chain Network Design
Why it is important?
Key points
1. Physical Network Decisions impact fixed costs of
the supply chain network
2. These decisions, once taken and implemented,
require effort and costs to change. So detailed
analysis of outcomes and scenarios is important.
3. Multiple changes to the network- new products, new
markets to serve, alternative modes of transport
may make the existing network sub optimal. Hence
a network design study becomes important.
 Conventional Network

Materials Customer
Vendor Finished Customer Store
DC DC
DC Goods DC

Customer
Component Store
Vendor Manufacturing
DC Plant Customer Customer
Warehouse DC Store
Components
DC Customer
Vendor Store
DC Finished
Customer
Goods DC
Final DC Customer
Assembly Store
 Tailored Network: Multi-Echelon Finished Goods
Network
Local DC
Cross-Dock Store 1
Regional Customer 1
Finished DC
Goods DC Store 1
Local DC
Cross-Dock
National Store 2
Finished Customer 2
DC
Goods DC
Local DC Store 2
Cross-Dock
Regional
Finished Store 3
Goods DC

Store 3
 Supply chain network design
§ Supply chain network design decisions include the

location of:

§ Manufacturing,

§ Storage, or transportation-related facilities and

§ The allocation of capacity and roles to each

facility.
 Network Design Decisions
• Facility role: What role should each facility play? What processes
should be performed at each facility?
Ø production, storage, cross-docking, processes performed and products
produced (flexibility)
• Facility location: Where should facilities be located?
Ø Very costly to open or close a plant
• Capacity allocation: How much capacity should be allocated to
each facility?
Ø Allocating too little or too much capacity is costly
Ø Capacity decisions would not change for years.
• Market and supply allocation: What markets should each
facility serve? Which supply sources should feed each facility?
Ø has Significant impact on performance
Ø Must be reconsidered on a regular basis
• (How many plants, DC’s, retail stores, etc. to build?)
 Factors Influencing
Network Design Decisions
Strategic

Technological

Macroeconomic

Political

Infrastructure

Competitive

Logistics and facility costs (Operational factors)

 …cont’d
Strategic factors

§ Convenience stores; many facilities for responsiveness

§ Discount stores; few large facilities for effectiveness

(low cost)

§ Different locations playing different role

Ølower priced for mass markets,

Øfocus on responsiveness and produce higher-priced

new design, with high variability.
 …cont’d
Technological factors
Ø Expensive dedicated production technologies will
require large production volumes and therefore a more
centralized production network (e.g., chip production).
Ø Lower fixed cost facilities can be duplicated more easily
(e.g., bottling factories).
Ø In case of non-homogeneous demand, technological
flexibility facilitates consolidation of production to a few
manufacturing facilities.
Ø The more cumbersome the transfer of raw material, the
closer the facility must be to the source site (e.g.,
factories processing minerals)
Macro economic factors …cont’d
§ Tariffs, Taxes incentives, and exchange rates
Ø Tariffs: Any duties that must be paid when products
and/or equipment are moved across international, state
or city boundaries.
ü High tariffs necessitate localized production.
Ø Presently, there is a systematic effort to open the markets
to global competition through the World Trade
Organization Policies (WTO) and regional agreements
Ø Tax incentives: a reduction in tariffs or taxes that
countries, states and cities often provide to encourage
firms to locate their facilities in specific areas.
 …Cont’d
§ Tax incentives can be focusing on certain Industries,
Technologies, and Regions

§ Quotas: Limits on import volumes placed by different

countries in an effort to protect their local industry.
Sometimes there is also some requirement on minimum
local content. (e.g. African Growth Opportunity Act -
AGOA)

§ Fluctuation in exchange rates has a significant impact on

the profits of any supply chain serving global markets.
 …cont’d
Political factors

§ Political stability, clear legal system, signing

international treatments.

§ The political stability of the country under

consideration plays a significant role in the
location choice.
 …cont’d
Infrastructure
• Availability of skilled labor
• Availability of transportation facilities
– Ports
– Airports
– Rail
– Highways
• Availability of necessary utilities
– Power
– Water
– Sewage
– Telecommunications / IT
 …cont’d

Competitive factors
§ Companies must consider competitors’ strategy, size,
and location when designing their SC networks.

§ Should the location be close to competitors or far

from them?
 …cont’d
Ø Positive Externalities: Instances where collocation of
multiple firms benefits all of them, since

§ They share the cost of the necessary infrastructure

§ And the collocation can stimulate demand for all of

them

§ Examples: industrial parks

Ø Locating to “split the market”: For companies that

ØDo not have price control, and
ØTry to maximize their market share by minimizing their
distance from the customer.
 …cont’d
Ø Customer response time and local presence
§ Convenience stores must locate close to customer
while the discount stores do not need to be close,
customers are ready to travel to buy larger quantities
with lower prices.
§ With faster transportation options, facilities can be
consolidated and away from customers.

Ø Logistics and facility costs

§ Inventory, transportation and facility cost should be

considered together.
 Costs and Number of Facilities

Inventory

Costs Facility costs

Transportation

Number of facilities
 Cost Buildup as a Function of Facilities
Total Costs
Cost of Operations

Percent Service
Level Within
Promised Time
Facilities
Inventory
Transportation
Labor

Number of Facilities
 A Framework for
Network Design Decisions
Ø When faced with a network design decision, the goal of
a manager is to design a network that maximizes the
firm’s profits while satisfying customer needs in terms
of demand and responsiveness.

Ø To design an effective network a manager must consider

all the factors described in the previous discussions.

Ø Global network design decisions are made in four

phases as shown in succeeding figure.
 A Framework for
Network Design Decisions
Competitive STRATEGY GLOBAL COMPETITION
PHASE I
Supply Chain
INTERNAL CONSTRAINTS Strategy
Capital, growth strategy, TARIFFS AND TAX
existing network INCENTIVES

PRODUCTION TECHNOLOGIES
REGIONAL DEMAND
Cost, Scale/Scope impact, PHASE II Size, growth, homogeneity,
support required, flexibility
Regional Facility local specifications
Configuration
COMPETITIVE
ENVIRONMENT POLITICAL, EXCHANGE
RATE AND DEMAND RISK

PHASE III
Desirable Sites AVAILABLE
INFRASTRUCTURE
PRODUCTION METHODS
Skill needs, response time

FACTOR COSTS PHASE IV LOGISTICS COSTS

Labor, materials, site specific Location Choices Transport, inventory, coordination
 Phase I: Supply chain Strategy Considerations
Ø Understand where is the main emphasis:
– Cost leadership
– Responsiveness
– Product differentiation
Ø Who are the key competitors at each target market?
Ø Identify constraints on available capital
Ø Key mechanisms that will support growth
– Reuse of existing facilities
– Build new facilities
– Partner with other companies (mergers and acquisitions are
potential options here)
 Models for Facility Location and Capacity
Allocation
• A manager’s goal when locating facilities and allocating
capacity should be to maximize the overall profitability
of the resulting supply chain network while providing
customers with appropriate responsiveness.
• Managers use network design models in two different
situations:
1.Models are used to decide on locations where facilities will
be established and the capacity to be assigned to each
facility.
2.Models are used to assign current demand to the available
facilities and identify lanes along which product will be
transported.
 …Cont’d
vInformation must be available before the design decision
can be made:
ØLocation of supply sources and markets
ØLocation of potential facility sites
ØDemand forecast by market
ØFacility, labor, and material costs by site
ØTransportation costs between each pair of sites
ØInventory costs by sites as well as a function of quantity
ØSale price of product in different regions
ØTaxes and tariffs as product is moved between locations
ØDesired response time and other service factors
 …Cont’d
vA typical network configuration problem involves large
amounts of data. This includes information on:
Ø Location of customers, retailers, existing warehouses and
distribution centers, manufacturing facilities and suppliers.
Ø All products, including volumes, special transport modes
(e.g., refrigerated).
Ø Annual demand for each product by customer location.
Ø Transportation rates by mode.
Ø Warehousing costs including: labor, inventory carrying
charges and fixed operating costs.
Ø Shipment sizes and frequencies for customer delivery.
Ø Customer service requirements and goals.
 …Cont’d

v After the required information is gathered

(Given the information), either gravity or
network optimization models may be used to
design the network.

v These models are selected based on the phases

of the network design frameworks.
 Phase II: Network optimization models

Competitive STRATEGY GLOBAL COMPETITION

PHASE I
Supply Chain
INTERNAL CONSTRAINTS Strategy
Capital, growth strategy, TARIFFS AND TAX
existing network INCENTIVES

PRODUCTION TECHNOLOGIES
REGIONAL DEMAND
Cost, Scale/Scope impact, PHASE II Size, growth, homogeneity,
support required, flexibility
Regional Facility local specifications
Configuration
COMPETITIVE
ENVIRONMENT POLITICAL, EXCHANGE
RATE AND DEMAND RISK

PHASE III
Desirable Sites AVAILABLE
INFRASTRUCTURE
PRODUCTION METHODS
Skill needs, response time

FACTOR COSTS PHASE IV LOGISTICS COSTS

Labor, materials, site specific Location Choices Transport, inventory, coordination
Phase II: Network optimization models
• During Phase II of the network design framework, a
manager must consider regional demand, tariffs,
economies of scale, and aggregate factor cost to
decide the regions in which facilities are to be located.
 …cont’d
• Allocating demand to production facilities
• Locating facilities and allocating capacity
Key Costs:
• Fixed facility cost
• Transportation cost
• Production cost
• Inventory cost
• Coordination cost
Which plants to establish? How to configure the network?
 The capacitated Plant location model
• The capacitated plant location network optimization
model requires the following inputs:
n= Number of potential plant locations/capacity
m= Number of markets or demand points
Dj= Annual demand from market j
Ki= Potential capacity of plant I
fi= Annualized fixed cost of keeping factory I open
cij= cost of production and shipping one unit from factory I to
market j ( cost includes production, inventory,
transportation, and duties.
 Plant Location with Multiple Sourcing

• yi = 1 if plant is located n n m

at site i, 0 otherwise Minå f y + åå c x ij ij

i i
i =1 i =1 j =1
• xij = Quantity shipped s.t.
from plant site i to n
customer j å x = D , j = 1,..., m
i =1
ij j

å x £ K y , i = 1,..., n
j =1
ij i i

å y £ k ; y Î{0,1}
i =1
i i

5-31
 Plant Location with Single Sourcing

Ø yi = 1 if plant is located n n m
Minå f y + åå D j c x
at site i, 0 otherwise i =1
i i
i =1 j =1
ij ij

Ø xij = 1 if market j is s.t.

supplied by factory i, 0 n

otherwise
åx
i =1
ij
= 1, j = 1,..., m
n

å D j x £ K y , i = 1,..., n
j =1
ij i i

xij , y Î{0,1}i
 Phase III: Desirable sites

Competitive STRATEGY GLOBAL COMPETITION

PHASE I
Supply Chain
INTERNAL CONSTRAINTS Strategy
Capital, growth strategy, TARIFFS AND TAX
existing network INCENTIVES

PRODUCTION TECHNOLOGIES
REGIONAL DEMAND
Cost, Scale/Scope impact, PHASE II Size, growth, homogeneity,
support required, flexibility
Regional Facility local specifications
Configuration
COMPETITIVE
ENVIRONMENT POLITICAL, EXCHANGE
RATE AND DEMAND RISK

PHASE III
Desirable Sites AVAILABLE
INFRASTRUCTURE
PRODUCTION METHODS
Skill needs, response time

FACTOR COSTS PHASE IV LOGISTICS COSTS

Labor, materials, site specific Location Choices Transport, inventory, coordination
• During phase III, a manager must identify potential
locations in each region where the company has decided
to locate a plant.

• As a preliminary step, the manager needs to identify the

geographical location where potential sites may be
considered.

• Gravity models can be useful when identifying suitable

geographical locations within a region.
• Gravity models are used to find locations that minimize the cost of
transporting raw materials from suppliers and finished goods to
the markets served.
 Gravity Methods for Location

Ø The basic inputs to the model are :

( x - xn) + ( y - y n)
2 2

– x,y: Warehouse Coordinates: (location d n

=

nx F
selected for facility)
å D k
n n
– xn, yn : Coordinates of delivery location n
x= n =1 d n

– dn : Distance to delivery location n D nF

k

– Fn : Annual tonnage to delivery location n

å d
n =1
n

D ny F
k

å d
n n

y= n =1 n

D nF
k

å
å d n Dn F n
n
Min d n =1 n

The total transportation cost (TC) is given by:TC = åd n Dn F n

 A Framework for
Network Design Decisions
Competitive STRATEGY GLOBAL COMPETITION
PHASE I
Supply Chain
INTERNAL CONSTRAINTS Strategy
Capital, growth strategy, TARIFFS AND TAX
existing network INCENTIVES

PRODUCTION TECHNOLOGIES
REGIONAL DEMAND
Cost, Scale/Scope impact, PHASE II Size, growth, homogeneity,
support required, flexibility
Regional Facility local specifications
Configuration
COMPETITIVE
ENVIRONMENT POLITICAL, EXCHANGE
RATE AND DEMAND RISK

PHASE III
Desirable Sites AVAILABLE
INFRASTRUCTURE
PRODUCTION METHODS
Skill needs, response time

FACTOR COSTS PHASE IV LOGISTICS COSTS

Labor, materials, site specific Location Choices Transport, inventory, coordination
 Phase IV: Location choice

ØDuring Phase IV, a manager must decide on the

location and capacity allocation for each facility.

1. Allocating demand to production facilities

2. Locating plants: The capacitated plant location model.
 Demand Allocation Model

n m

! Which market is served Minåå cij xij

i =1 j =1

by which plant? s.t.

n
! Which supply sources åx
i =1
ij
= D j
, j = 1,..., m

are used by a plant? m

åx ij
£ K i
, i = 1,..., n
xij = Quantity shipped from j =1

plant site i to customer j

x ij
³0
 Locating Plants and Warehouses
Simultaneously
Ø A much general form of the plant location model needs
to be considered if the entire SC network from the
supplier to the customer must be designed.

Ø We consider a SC in which suppliers send material to

factories that supply warehouses that supply markets
Ø Location and capacity allocation decisions have to be
made for both factories and warehouses.
Ø Multiple warehouses and multiple factories may be used.
 Locating Plants and Warehouses
Simultaneously
Supplier Plants Warehouses Markets

Fig. Stages in a supply chain

§ The model requires:
m= Number of markets or demand points
n= Number of potential factory locations
l= Number of suppliers
t= Number of potential warehouse locations
Dj= Annual demand from customer j
Ki= Potential capacity of factory at site i
Sh= Supply capacity at supplier h
We= Potential warehouse capacity at site e
fi= Fixed cost of locating a plant at site i
fe= Fixed cost of locating a warehous at site e
chi= Cost of shipping one unit from supply source h to factory i
cie= Cost of producing and shipping one unit from factory i to warehouse e
cej= Cost of shipping one unit from warehouse e to customer j
 Plants and Warehouses Simultaneously
• The goal is to identify plant and warehouse locations as
well as quantities shipped between varies points that
minimize the total fixed and variable costs.
§ Define the following decision variables
yi= 1 if factory is located at site i, 0 otherwise
ye= 1 if warehouse is located at site e, 0 otherwise
xej= Quantity shipped from warehouse e to market j
xie= Quantity shipped from factory at site i to warehouse e
xhi= Quantity shipped from supplier h to factory at site i

The proble is formulated as:

 Plants and Warehouses Simultaneously

n t l n
Min(å f y + å f y + åå c x hi hi
i i e e
i =1 e =1 h =1 i =1
n t t m
+ åå cie xie + åå cej xej )
i =1 e =1 e =1 j =1
 Description of constriants
Total amount shipped from supplier can not exceed suppliers
capacity

Amount shipped out of factory cannot exceed the quantity of raw

material received

Units produced in factory cannot exceed factory capacity

Amount shipped out of warehouse cannot exceed quantity

received from factories

Amount shipped through warehouses cannot exceed its capacity

Amount shipped to customer must equal the customer demand

Each factory or a warehouse is either open or closed

s.t.
n

åx
i =1
hi
£ s h
forh = 1,..., l
n n

åx
i =1
hi
- å x ie
>=
i =1
0 fori = 1,..., n
t

åx
e =1
ie
£ K y i i
, i = 1,..., n
n n

åx
i =1
ie
- å xej >= 0 fore = 1,..., t
i =1
m

å x £W y
j =1
ej e e
fore = 1,..., t

åx
e =1
ej
= Dj forj = 1,..., m

y , y Î{0,1}
i e
Network Design in an
Uncertain Environment
 The Impact of Uncertainty
on Network Design
Ø Supply chain design decisions include investments in
number and size of plants, number of trucks, number of
warehouses.
Ø These decisions cannot be easily changed in the short-
term
Ø There will be a good deal of uncertainty in demand,
prices, exchange rates, and the competitive market over
the lifetime of a supply chain network
Ø Therefore, building flexibility into supply chain operations
allows the supply chain to deal with uncertainty in a
manner that will maximize profits
 Practical issues in network design decisions

§ Do not underestimate the life-span of the facilities

§ Do not ignore the cultural issues and implications

§ Do not ignore the quality of life issues

§ Focus on tax and tariffs and incentives

 The Role of IT in Network Design
! IT systems help with network design by:
1. Making the modeling of the network design
problems easier

2. Containing high-performance optimization

technologies

3. Allowing for “what-if” scenarios

4. Interfacing with planning and operational software

! What is the role of network design decisions in the
supply chain?

! What are the factors influencing supply chain network

design decisions?

! Describe a strategic framework for facility location.

! How are the following optimization methods used for

facility location and capacity allocation decisions?
– Gravity methods for location

– Network optimization models

Thank You!