Designing Distribution Networks

Learning Objectives

 Understand the role of distribution in the supply chain and

factors influencing distribution network design
 Identify the key factors to be considered when designing
the distribution network
 Define the strengths and weaknesses of various distribution
options
 Understand the roles of distributors play in the supply chain
and the role of network design decisions in the supply chain
 Describe a strategic framework for facility location
 The Role of Distribution
in the Supply Chain

 Distribution: the steps taken to move and store

a product from the supplier stage to the
customer stage in a supply chain
 Distribution directly affects cost and the customer
experience and therefore drives profitability
 Choice of distribution network can achieve supply
chain objectives from low cost to high
responsiveness
 Examples: Wal-Mart, Dell, Proctor & Gamble,
Grainger
 Factors Influencing
Distribution Network Design

 Distribution network performance is evaluated

along two dimensions at the highest level:
 Customer needs that are met
 Cost of meeting customer needs
 Distribution network design options must
therefore be compared according to their impact
on customer service and the cost to provide this
level of service
 Factors Influencing
Distribution Network Design [2]

 Elements of customer service influenced by network

structure:
 Response time
 Product variety
 Product availability
 Customer experience
 Time to market
 Order visibility
 Returnability
 Supply chain costs affected by network structure:
 Inventories
 Transportation
 Facilities and handling
 Information
 Service and Number of Facilities

Required
Number of
Facilities

Desired
Response Time
 Inventory Costs & Number of Facilities

Inventory
Costs

Number of facilities
 Transportation Costs and
Number of Facilities

Transportation
Costs

Number of facilities
 Facility Costs and Number
of Facilities

Facility
Costs

Number of facilities
Variation in Logistics Costs and Response
Time with Number of Facilities

Response Time

Total Logistics Costs

Number of Facilities
 Design Options for a
Distribution Network

1. Manufacturer Storage with Direct Shipping

2. Manufacturer Storage with Direct Shipping and
In-Transit Merge
3. Distributor Storage with Carrier Delivery
4. Distributor Storage with Last Mile Delivery
5. Manufacturer or Distributor Storage with
Customer Pickup
6. Retail Storage with Customer Pickup

Six groups, each of which represents one

distribution network!
Manufacturer Storage with
Direct Shipping

Manufacturer

Retailer

Customers

Product Flow
Information Flow
 Performance Characteristics of Manufacturer
Storage with Direct Shipping Network

Cost Factor Performance

Inventory Lower costs because of aggregation. Benefits of aggregation are highest for low-demand,
high-value items. Benefits are very large if project customization can be postponed at the
manufacturer
Transportation Higher transportation costs because of increased distance and disaggregate shipping

Facilities and handling Lower facility costs because of aggregation. Some saving on handling costs if manufacturer can
manage small shipments or ship from production line
Information Significant investment in information infrastructure to integrate manufacturer and retailer

Service Factor Performance

Response time Long response time of one to two weeks because of increased distance and two stages for order
processing. Response time may vary by product, thus complicating receiving
Product variety Easy to provide a very high level of variety

Product availability Easy to provide a high level of product availability because of aggregation at manufacturer

Customer experience Good in terms of home delivery but can suffer if order from several manufacturers is sent
as partial shipments
Time to market Fast, with the product available as soon as the first unit is produced

Order visibility More difficult but also more important form a customer service perspective

Returnability Expensive and difficult to implement

 In-Transit Merge Network

Factories

Retailer In-Transit Merge by

Carrier

Customers

Product Flow
Information Flow
 Performance Characteristics of In-Transit
Merge

Cost Factor Performance

Inventory Lower costs because of aggregation. Benefits of aggregation are highest for low-demand,
high-value items. Benefits are very large if project customization can be postponed at the
manufacturer (Similar to drop-shipping)
Transportation Somewhat lower transportation costs than drop-shipping

Facilities and handling Handling costs higher than drop-shipping at carrier, receiving costs lower at customer

Information Investment is somewhat higher than for drop-shipping

Service Factor Performance

Response time Long response time of one to two weeks because of increased distance and two stages for order
processing. Response time may vary by product, thus complicating receiving (Similar to drop-
shipping, maybe higher)
Product variety Easy to provide a very high level of variety (Similar to drop-shipping, maybe higher)

Product availability Easy to provide a high level of product availability because of aggregation at
manufacturer(Similar to drop-shipping, maybe higher)
Customer experience Better than drop-shipping because only a single delivery has to be received

Time to market Fast, with the product available as soon as the first unit is produced (Similar to drop-shipping,
maybe higher)
Order visibility More difficult but also more important form a customer service perspective(Similar to drop-
shipping, maybe higher)
Returnability Expensive and difficult to implement (Similar to drop-shipping, maybe higher)
Distributor Storage with
Carrier Delivery

Factories

Warehouse Storage by
Distributor/Retailer

Customers

Product Flow
Information Flow
 Performance Characteristics of Distributor
Storage with Carrier Delivery

Cost Factor Performance

Inventory Higher than manufacturer storage. Difference is not large for faster-moving items

Transportation Lower than manufacturer storage. Reduction is highest for faster-moving items

Facilities and handling Somewhat higher than manufacturer storage. The difference can be large for very slow-
moving items
Information Simpler infrastructure compared to manufacturer storage

Service Factor Performance

Response time Faster than manufacturer storage

Product variety Lower than manufacturer storage

Product availability Higher cost to provide the same level of availability as manufacturer storage

Customer experience Better than manufacturer storage with drop-shipping

Time to market Higher than manufacturer storage

Order visibility Easier than manufacturer storage

Returnability Easier than manufacturer storage

Distributor Storage with
Last Mile Delivery

Factories

Distributor/Retailer
Warehouse

Customers

Product Flow
Information Flow
 Performance Characteristics of Distributor
Storage with Last-Mile Delivery

Cost Factor Performance

Inventory Higher than distributor storage with package carrier delivery

Transportation Very high cost given minimal scale economies. Higher than any other distribution option

Facilities and handling Facility costs higher than manufacturer storage or distributor storage with package
carrier delivery, but lower than a chain of retail stores
Information Simpler infrastructure compared to manufacturer storage

Service Factor Performance

Response time Very quick. Same day to next-day delivery

Product variety Somewhat less than distributor storage with package carrier delivery but larger than
retail stores
Product availability More expensive to provide availability than any other option except retail stores

Customer experience Very good particularly for bulky items

Time to market Slightly higher than distributor storage with package carrier delivery

Order visibility Less of an issue and easier to implement than manufacturer storage or distributor storage
with package carrier delivery
Returnability Easier to implement than other options. Harder and more expensive than a retail network
 Manufacturer or Distributor Storage with
Customer Pickup

Factories

Retailer Cross Dock DC

Pickup Sites

Customers

Customer Flow
Product Flow
Information Flow
 Performance Characteristics of
Manufacturer/Distributor Storage with
Customer Pickup Sites
Cost Factor Performance

Inventory Can match any other option, depending on the location of inventory

Transportation Lower than the use of package carriers, especially if using an existing delivery network

Facilities and handling Facility costs can be very high if new facilities have to be built. Costs are lower if existing
facilities are used. The increase in handling cost at the pickup site can be significant
Information Significant investment in infrastructure required

Service Factor Performance

Response time Similar to package carrier delivery with manufacture or distributor storage. Same-day
delivery is possible for items stored locally at pickup sites
Product variety Similar to other manufacture or other distributor storage options.

Product availability Similar to other manufacture or other distributor storage options.

Customer experience Lower than any other options because of the lack of home delivery. In areas with high
density of population, loss of convenience may be small
Time to market Similar to other manufacture or other distributor storage options.

Order visibility Difficult but essential

Returnability Somewhat easier given that pickup location can handle returns
 Performance Characteristics of Retail Storage
with Customer Pickup

• Inventory is stored locally at retail stores

Cost Factor Performance

Inventory Higher than all other options

Transportation Lower than all other options

Facilities and handling Higher than other options. The increase in handling cost at the pickup site can be
significant for online and phone orders
Information Some investment in infrastructure required for online and phone orders

Service Factor Performance

Response time Same day (immediate) pickup possible for items stored locally at pickup site

Product variety Lower than all other options

Product availability More expensive to provide than all other options

Customer experience Related to whether shopping is viewed as a positive or negative experience by customer

Time to market Highest among distribution options

Order visibility Trivial for in-store orders. Difficult, but essential, for online and phone orders

Returnability Easier than other options given that pickup location can handle returns
Impact of Online Sales on Customer Service

• Response time to customers

– Physical products take longer to fulfill than
retail store
– No delay for information goods
• Product variety
– Easier to offer larger selection
• Product availability
– Aggregating inventory and better information
on customer preferences improves product
availability
 Impact of Online Sales on Customer Service

 Customer experience
 Improved access, customization, and
convenience
 Faster time to market
 Order Visibility
 Returnability
 Harder with online orders
 Proportion of returns likely to be much higher
 Impact of Online Sales on Customer Service

Direct Sales to Customers

 Social networking channels allow firms to directly
pitch products and promotion
Flexible Pricing, Product Portfolio,
and Promotions
 Manage revenues from product portfolio more
effectively than traditional channels
 Promotion information can be conveyed to
customers quickly and inexpensively
Efficient Funds Transfer
 Impact of Online Sales on Cost

 Inventory
 Lower inventory levels if customers will wait
 Postpone variety until after the customer
order is received
 Facilities
 Costs related to the number and location of
facilities in a network
 Costs associated with the operations in these
facilities
 Impact of Online Sales on Cost

 Transportation
 Lower cost of “transporting” information goods
in digital form
 For nondigital, aggregating inventories
increases outbound transportation
 Information
 Share demand, planning, and forecasting
information throughout its supply chain
 Additional costs to build and maintain the
information infrastructure
 Online Sales Scorecard

Area Impact
Response time
Product variety
Product availability
Customer experience
Time to market
Order visibility
Direct sales
Flexible pricing, portfolio, promotions
Efficient funds transfer
Inventory
Facilities
Transportation
Information
Key: +2 = very positive; +1 = positive; 0 = neutral; −1 = negative; −2 =
very negative. Table 4-9
Using Online Sales to Sell Computer
Hardware: Dell

Figure 4-11
 Using Online Sales to Sell Computer
Hardware: Dell

 A tailored supply chain network

 A hybrid model can be very effective
 More significant as hardware becomes
more of a commodity
 Take advantage of the strengths of both
online sales and traditional retail and
distribution channels
 Using Online Sales to Sell Computer
Hardware: Dell

 Impact of online sales on customer

service
 Delay in fulfilling customer request
 Impact of online sales on cost
 Reduced inventory costs
 Lower facility costs
 Higher total transportation costs
 Incremental increase in information costs
Using Online Sales to Sell Books: Amazon

 Impact of online sales on customer

service
 Internet has not shortened supply chains
 Increased selection, convenience
 Impact of online sales on cost
 Reduced inventory costs
 Lower facility costs
 Higher total transportation costs
 Increase in information costs
Using Online Sales to Sell Books: Amazon

 A supply chain network for books

 Traditional bookstores pressured from
both ends
 Amazon more efficient
Using the Internet to Sell Groceries: Peapod

 Impact of online sales on customer

service
 Sell convenience and the time savings
 Offers less variety
 Creating a personalized shopping
experience and customized advertising
and promotions
Using the Internet to Sell Groceries: Peapod

 Impact of online sales on cost

 Reduced inventory costs
 Higher facility costs due to picking
operation
 Significantly higher total transportation
costs
 Increase in information costs
Using Internet to Sell Groceries: Peapod

 Value of online sales to a traditional

grocery chain
 Complement the strengths of their existing
network
 Offer an entire array of services at
differing prices based on the amount of
work the customer does
Using the Internet to Rent Movies: Netflix

 Impact of online sales on customer

service
 Staggering selection and an excellent
recommendation engine
 Video streaming through a variety of
devices
 Customers received their DVDs within 24
hours of being shipped
Using the Internet to Rent Movies: Netflix

 Impact of online sales on cost

 Reduced inventory costs
 Lower facility costs
 Considerably higher total transportation
costs, increased streaming will reduce
transportation costs
 Increase in information costs
 Distribution Networks in Practice

1. The ownership structure of the

distribution network can have as big as
an impact as the type of distribution
network
2. It is important to have adaptable
distribution networks
3. Product price, commoditization, and
criticality affect the type of distribution
system preferred by customers
4. Integrate the Internet with the existing
physical network
 Distribution Networks in Practice

 Consider whether an exclusive distribution

strategy is advantageous
 Product, price, commoditization, and criticality
have an impact on the type of distribution system
preferred by customers
Analyze Table 1 (page 97)
Give explanation for each row (criterion):
 Why a particular distribution network is identified as
having the strongest performance for a criterion and vice
versa?

Analyze Table 2 (page 98)

Give explanation for each row (product criterion)
 Why a particular distribution network is identified as
very suitable for a product criterion and vice versa?
 Comparative Performance of Delivery
Network Designs
Retail Manufacturer Manufacturer Distributor Distributor Manufacturer
Storage with Storage with Storage with In- Storage with storage with storage with
Customer Direct Shipping Transit Merge Package Carrier last mile pickup
Pickup Delivery delivery

Response Time 1 4 4 3 2 4

Product Variety 4 1 2 3
1 1

Product Availability 2 3
4 1 1 1

Customer 5
~ 4 3 2 1
Experience
1 5 4 3 2 6
Order Visibility

Returnability 5 5 4 3 2
1

Inventory 4 1 1 2 3 1

Transportation 1 4 3 2 5 1

Facility & Handling 6 1 2 3 4 5

Information 1 4 4 3 2 5

Key: 1 corresponds to the strongest performance and 6 the weakest performance

 Performance of Delivery Networks for Different
Product/Customer Characteristics

Retail Storage Manufacturer Manufacturer Distributor Storage Distributor storage Manufacturer

with Storage with Storage with In- with Package Carrier with last mile delivery storage with
Customer Direct Shipping Transit Merge Delivery pickup
Pickup

High demand product

+2 -2 -1 0 +1 -1
Medium demand product
+1 -1 0 +1 0 0
Low demand product
-1 +1 0 +1 -1 +1
Very low demand product
-2 +2 +1 0 -2 +1
Many product sources
+1 -1 -1 +2 +1 0
High product value
-1 +2 +1 +1 0 +2
Quick desired response
+2 -2 -2 -1 +1 -2
High product variety
-1 +2 0 +1 0 +2
Low customer effort
-2 +1 +2 +2 +2 -1
Key: +2 = very suitable, +1 = somewhat suitable. 0 = neutral, -1 = somewhat unsuitable, -2 = very unsuitable
(Group 1 & 2)
a) A bicycle company is considering expanding its
operations into China, where five companies dominate
the consumption of bicycle. What sort of distribution
network should this company utilize?

(Group 3 & 4)
b) A distributor has heard that one of the major
manufacturers from which it buys is considering going
direct to the consumer. What can the distributor do
about this? What advantages can it offer the
manufacturer that the manufacturer is unlikely to be
able to reproduce?
Network Design in the Supply Chain
 Network Design Decisions

 Facility role
 What role should each facility play? What
processes are performed at each facility?
 Facility location
 Where should facilities be located?
 Capacity allocation
 How much capacity should be allocated to
each facility?
 Market and supply allocation
 What markets should each facility serve?
Which supply sources should feed each
facility?
 The Role of Network Design in the Supply
Chain

 Network design decisions have a significant

impact on performance because they:
 determine the supply chain configuration
 set constraints within which the other supply chain
drivers can be used either to decrease supply chain cost
or to increase responsiveness
 Network design decision must be revisited:
 as a firm grows
 when two companies mergers
 costs e.g. transportation, etc have changed significantly
 Factors Influencing
Network Design Decisions

 Strategic
 Technological
 Macroeconomic (tariffs and tax incentives,
exchange rate and demand risk)
 Political
 Infrastructure
 Competitive
 Logistics and facility costs
 Strategic Factors

 Offshore facility: low-cost facility for export production

 Source facility: low-cost facility for global production
 Server facility: regional production facility (supply the
market where it is located because of tax incentives, local
content requirement, tariff barriers, high logistic cost)
 Contributor facility: regional production facility with
development skills (serve the market where it is located but
also assumes responsibility for product customization and
development, process improvements)
 Outpost facility: regional production facility built gain
local skills
 Lead facility: facility that leads in development and
process technologies
 Framework for Network Design Decisions

 Phase I – Supply Chain Strategy

 Phase II – Regional Facility Configuration
 Phase III – Desirable Sites
 Phase IV – Location Choices
 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, support PHASE II Size, growth, homogeneity,
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
 Network Optimization Models

 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?

 Capacitated Plant Allocation Model

Allocate the demand from different markets to the various plants to

minimize the total cost of facilities, transportation and inventory
n m
 Which market is served by which Min  cij xij
plant? i 1 j 1

 Which supply sources are used by s.t.

a plant?
n

n = number of factory locations

x i 1
ij
 D j
, j  1,..., m a

m = number of markets or demand m

points x ij
 K i
, i  1,..., n b

Dj = annual demand from market j j 1

Ki = capacity of factory i 0
cij = cost of producing and shipping
x ij

one unit from factory i to market j

(cost includes production,
inventory and transportation)
xij = Quantity shipped from plant site i
to customer j
a Ensure that all market
demand is satisfied
b Ensure that no factory
produces more than its
capacity
 Plant Location with Multiple Sourcing

 fi = annualized fixed cost of

keeping factory i open n n m
 yi = 1 if plant is located at site Min  f y   c x ij ij
i i
i, 0 otherwise i 1 i 1 j 1
 xij = Quantity shipped from
plant site i to s.t.
customer/market j n
 cij = cost of producing and
shipping one unit from factory  x  D , j  1,..., m
ij j
i to market j (cost includes i 1
production, inventory and n
transportation)
 Dj = annual demand from  x  K y , i  1,..., n
j 1
ij i i
market j
 Ki = capacity of factory i m

 y  k ; y {0,1}
i 1
i i
See excel: Steel Appliances
 Plant Location with Single Sourcing

• companies want to design supply chain networks in which a market is supplied

from only one factory, referred to as a single source
• companies may impose this constraint because it lowers the complexity of
coordinating the network and requires less flexibility from each facility
n n m
fi = cost of shipping
Min  f y    D jc x

 yi = 1 if plant is located at site i, 0 i i ij ij
i 1 i 1 j 1
otherwise
 xij = 1 if market j is supplied by factory s.t.
i, 0 otherwise
n
 cij = cost of producing and shipping
one unit from factory i to market j x ij
 1, j  1,..., m a
(cost includes production, inventory i 1
and transportation) n


Dj = annual demand from market j
Ki = capacity of factory i
D jx
j 1
ij
 K y , i  1,..., n
i i
b

xij , y {0,1}i

a & b enforce that each market is

supplied by exactly one factory
 Models for Facility Location and Capacity
Allocation: Gravity Methods for Location

Find locations that minimize the cost of transporting raw material from
suppliers and finished goods to the market served

( x  x n)  ( y y
2 2

 Ton Mile-Center Solution dn  n)

 x,y: warehouse coordinate
 x’, y’ = new location for the facility

k
Dn x Fn n

 xn, yn : Coordinate location of either

x n 1 d n
a market or supply source n
D nF
k
 dn : Distance to delivery location n
 Dn : quantity to be shipped between
 d
n 1
n

n
facility and market or supply source
n D ny F
k

 Fn : cost of shipping one unit for  d

n n

one mile between the facility and y n 1 n

either market or supply source n
D nF
k
 TC = total transportation cost  d
n 1
n

TC = Min  d n Dn F n
 Example Gravity Methods for Location

 Steel Appliances (SA), a manufacturer of high-quality

refrigerators and cooking ranges
 SA has one assembly factory located near Denver, from
which it has supplied the entire US
 Demand has grown rapidly and the CEO of SA has decided
to set up another factory to serve its eastern markets
 Three parts plants located in Buffalo, Memphis and
St.Louis will supply parts to the new factory, which will
serve markets in Atlanta, Boston, Jacksonville,
Philadelphia and New York
 The supply chain manager is asked to find a suitable
location for the new factory
Example Gravity Methods for Location [2]

Transportation Cost
Sources/ $/Ton Mile Tons Coordinates
Markets Fn Dn xn yn dn
Buffalo 0.90 500 700 1200 1389
Sources Memphis 0.95 300 250 600 650
St. Louis 0.85 700 225 825 855
Atlanta 1.50 225 600 500 781
Boston 1.50 150 1050 1200 1595
Markets Jacksonville 1.50 250 800 300 854
Philadelphia 1.50 175 925 975 1344
New York 1.50 300 1000 1080 1472

Facility Location

The manager thus identifies that

x= 0.0
coordinates (x,y) = (681, 882)
y= 0.0 as the location of the factory
that minimizes total
Cost = $ 3,277,110 transportation cost
 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
 Making Network Design Decisions In Practice

 Do not underestimate the life span of facilities

 Do not gloss over the cultural implications
 Do not ignore quality of life issues
 Focus on tariffs and tax incentives when locating
facilities
 References

 Chopra S. and P. Meindl, Supply Chain

Management, 5e, Prentice Hall, 2013
 Handfield, Monczka, Giunipero and Patterson,
Sourcing and Supply Chain Management, 4e,
South-Western, 2009
 Cachon and Terwiesch, An Introduction to
Operations Management, 2e, McGraw-Hill, 2009
 Assignment 3

 Assignment 3:
Exercise Ch. 5, number 1&2

 Deadline: 1 week (see SCELE)

 Softcopy