Network Planning

Why Network Planning?

Find the right balance between inventory, transportation and manufacturing costs Match supply and demand under uncertainty by positioning and managing inventory effectively Utilize resources effectively by sourcing products from the most appropriate manufacturing facility

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. 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 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?

Inventory positioning:

Resource allocation:

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

Reevaluation of Infrastructure

Changes in:

demand patterns product mix production processes

sourcing strategies
cost of running facilities.

Mergers and acquisitions may mandate the integration of different logistics networks

Key Strategic Decisions

Determining the appropriate number of facilities such as plants and warehouses. Determining the location of each facility. Determining the size of each facility. Allocating space for products in each facility. Determining sourcing requirements. Determining distribution strategies, i.e., the allocation of customers to warehouse

Objective and Trade-Offs

Objective: Design or reconfigure the logistics network in order to minimize annual system-wide cost subject to a variety of service level requirements Increasing the number of warehouses typically yields:

An improvement in service level due to the reduction in average travel time to the customers An increase in inventory costs due to increased safety stocks required to protect each warehouse against uncertainties in customer demands. An increase in overhead and setup costs A reduction in outbound transportation costs: transportation costs from the warehouses to the customers An increase in inbound transportation costs: transportation costs from the suppliers and/or manufacturers to the warehouses.

Data Collection

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

Data Aggregation

Customer Zone

Aggregate using a grid network or other clustering technique for those in close proximity. Replace all customers within a single cluster by a single customer located at the center of the cluster Five-digit or three-digit zip code based clustering.
Distribution pattern
Products picked up at the same source and destined to the same customers Logistics characteristics like weight and volume.

Product Groups

Product type

product models or style differing only in the type of packaging.

Replacing Original Detailed Data with Aggregated Data

Even if technology exists to solve the logistics network design problem with the original data, Data aggregation still useful because forecast demand is significantly more accurate at the aggregated level. Aggregating customers into about 150-200 zones usually results in no more than a 1 percent error in the estimation of total transportation costs

Transportation Rates

Rates are almost linear with distance but not with volume Differences between internal rate and external rate

Internal Transportation Rate

For company-owned trucks Data Required:

Annual costs per truck

Annual mileage per truck

Annual amount delivered Trucks effective capacity

Calculate cost per mile per SKU.

External Transportation Rate

Two modes of Truck Transportation

Truckload, TL Less-Than-Truckload, LTL

Circuity Factor,

Equations underestimate the actual road distance. Multiply Dab by .

Typical values:

= 1.3 in intra-city areas = 1.14 for inter-city areas

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.
Inventory holding costs Proportional to average positive inventory levels.

Storage costs

Determining Fixed Costs

Warehouse fixed costs as a function of the warehouse capacity

Determining Storage Costs

Multiply inventory turnover by holding cost Inventory Turnover =

Annual Sales / Average Inventory Level

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

Warehouse Capacity Example

Annual flow = 1,000 units Inventory turnover ratio = 10.0 Average inventory level = 100 units

Assume each unit takes 10 sqft. of space

Required space for products = 2,000 sqft.

Total space required for the warehouse is about 6,000 square feet

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

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

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

Number of Warehouses
$90 $80

Optimal Number of Warehouses

Cost (millions $)

$70 $60 $50 $40 $30 $20 $10 $Total Cost Transportation Cost Fixed Cost Inventory Cost

10

Number of Warehouses

Industry Benchmarks: Number of Distribution Centers

Pharmaceuticals Food Companies Chemicals

Avg. # of WH

3
- High margin product - Service not important (or easy to ship express) - Inventory expensive relative to transportation

14

25
- Low margin product - Service very important - Outbound transportation expensive relative to inbound

Model Validation

Reconstruct the existing network configuration using the model and collected data Compare the output of the model to existing data Compare to the companys accounting information

Often the best way to identify errors in the data, problematic assumptions, modeling flaws.

Make local or small changes in the network configuration to see how the system estimates impact on costs and service levels.

Positing a variety of what-if questions. Does the model make sense? Are the data consistent? Can the model results be fully explained? Did you perform sensitivity analysis?

Answer the following questions:

Solution Techniques

Mathematical optimization techniques: 1. Exact algorithms: find optimal solutions 2. Heuristics: find good solutions, not necessarily optimal

Simulation models: provide a mechanism to evaluate specified design alternatives created by the designer.

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 market areas c1,c2 and c3 with demands of 50,000, 100,000 and 50,000, respectively.

Unit Distribution Costs

Facility warehouse
w1 w2

p1

p2

c1

c2

c3

0 5

4 2

3 2

4 1

5 2

Heuristic #1:
Choose the Cheapest Warehouse to Source Demand

D = 50,000
$2 x 50,000

$5 x 140,000
$1 x 100,000

D = 100,000

Cap = 60,000

$2 x 60,000

$2 x 50,000

D = 50,000

Total Costs = $1,120,000

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 $3 $4 $2

D = 50,000
P1 to WH1 P1 to WH2 P2 to WH1 P2 to WH 2 $3 $7 $7 $4

$5

$5
$4 $1 $2 $2

D = 100,000
P1 to WH1 P1 to WH2 P2 to WH1 P2 to WH 2 $4 $6 $8 $3

Cap = 60,000

D = 50,000
P1 to WH1 P1 to WH2 P2 to WH1 P2 to WH 2 $5 $7 $9 $4

Market #1 is served by WH1, Markets 2 and 3 are served by WH2

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 $3 x 50,000

D = 50,000
P1 to WH1 P1 to WH2 P2 to WH1 P2 to WH 2 $3 $7 $7 $4

Cap = 200,000
$5 x 90,000
$1 x 100,000

D = 100,000
P1 to WH1 P1 to WH2 P2 to WH1 P2 to WH 2 $4 $6 $8 $3

Cap = 60,000

$2 x 60,000 $2 x 50,000

D = 50,000
P1 to WH1 P1 to WH2 P2 to WH1 P2 to WH 2 $5 $7 $9 $4

Total Cost = $920,000

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

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.

Optimal Solution
Facility warehouse w1 w2 p1 p2 c1 c2 c3 140,000 0 0 60,000 50,000 0 40,000 60,000 50,000 0

Total cost for the optimal strategy is $740,000

Simulation Models

Useful for a given design and a micro-level analysis. Examine:

Individual ordering pattern. Specific inventory policies.

Inventory movements inside the warehouse.

Not an optimization model Can only consider very few alternate models

Which One to Use?

Use mathematical optimization for static analysis Use a 2-step approach when dynamics in system has to be analyzed:
Use an optimization model to generate a number of least-cost solutions at the macro level, taking into account the most important cost components. Use a simulation model to evaluate the solutions generated in the first phase.

Key Features for Network Design

Flexibility to incorporate a large set of preexisting network characteristics, like

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 Relative quality of the solution independent of specific environment, data variability or specific settings

Robustness

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?

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.
SI T S

Net Lead Time = SI + T - S

Safety stock at the facility:

zh SI T S

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.

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.

Local vs. Global Optimization

Trade-off between quoted lead time and safety stock

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.

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. Low inventory turns Inconsistent service levels across locations and products, and The need to expedite shipments, with resulting increased transportation costs

This typically yields leads to:

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?

Integrating Inventory Positioning and Network Design

Sample plot of each SKU by volume and demand

Three Different Product Categories

High variability - low volume products Low variability - high volume products, and Low variability - low volume products.

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. Require more analysis since other characteristics are important, such as profit margins, etc.

Low variability low volume products

Resource Allocation

Supply chain master planning The process of coordinating and allocating production, and distribution strategies and resources to maximize profit or minimize system-wide cost Process takes into account: interaction between the various levels of the supply chain identifies a strategy that maximizes supply chain performance

Global Optimization and DSS

FACTORS TO CONSIDER

Facility locations: plants, distribution centers and demand points Transportation resources including internal fleet and common carriers Products and product information Production line information such as min lot size, capacity, costs, etc. Warehouse capacities and other information such as certain technology (refrigerators) that a specific warehouse has and hence can store certain products Demand forecast by location, product and time.

Focus of the Output

Sourcing Strategies:

where should each product be produced during the planning horizon, OR

Supply Chain Master Plan:

production quantities, shipment size and storage requirements by product, location and time period.