5

Network Design in
the Supply Chain

PowerPoint presentation to accompany

Chopra and Meindl Supply Chain Management, 5e
Global Edition
Copyright ©2013 Pearson Education.

1-1
5-1
 Learning Objectives
1. Understand the role of network design in a
supply chain.
2. Identify factors influencing supply chain
network design decisions.
3. Develop a framework for making network
design decisions.
4. Use optimization for facility location and
capacity allocation decisions.

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 Network Design Decisions
• Facility role
– What role, what processes?
• Facility location
– Where should facilities be located?
• Capacity allocation
– How much capacity at each facility?
• Market and supply allocation
– What markets? Which supply sources?

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 Factors Influencing
Network Design Decisions

• Strategic factors
• Technological factors
• Macroeconomic factors
– Tariffs and tax incentives
– Exchange-rate and demand risk
– Freight and fuel costs
• Political

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 Factors Influencing
Network Design Decisions

• Infrastructure factors
• Competitive factors
– Positive externalities between firms
– Locating to split the market
• Customer response time and local
presence
• Logistics and facility costs

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 Strategic Roles of a Facility
• Offshore facility: Low cost facility for export
production
• Source Facility: Low cost facility for global
production
• Server Facility: Regional Production Facility
• Contributor Facility: Regional Production Facility
with Development Skills
• Outpost Facility: Regional Production Facility
built to gain local skills
• Lead Facility: Facility that leads in development
and process technologies

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 Technological Factors
• Characteristics of available production
technologies have a significant impact on the
network design:
– If production technology provide significant
economies of scale, few high capacity locations are
the most effective
– If facilities have lower fixed costs, many local facilities
are preferred.
• Flexibility of the production technology impacts
the degree of consolidation in the network:
– If the production technology is inflexible, build many
local facilities
– Else, build few but large facilities
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 Macroeconomic Factors
• Tariffs and tax incentives
– Tariffs: Any duties that must be paid when
product, equipment are moved across an
international, state or city boundry.
– Developing countries have free trade zones
• Exchange rate and demand risk
– Valuable TRL and textile industry in Turkey

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 Infrastructure Factors
• Availability of sites
• Availability of labor
• Proximity to transportation terminals,
railservice, airports, seaports,
• Highway access
• Congestion
• Local utilities

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 Competitive Factors
• Positive externalities between firms
– Ex: Gas stations and retail shops
Auto Repair Districts
• Locating to Split the market
– When firms do not control price, but compete
on distance from the customer, they can
maximize market share by locating close to
each other and splitting the market

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 Ex:Locating to Split the
Market
• Let there be two firms located
at points a and 1-b on a line
segment between 0 and 1. Let
the customers be located 0 a 1-b 1
uniformly on this line. a 1 b
If the total demand is 1, the 2
demand at the two firms is
maximized when a=b=1/2. a 1 b 1 b  a
d1  , d2 
2 2
Thus both firms maximize their
market share when they move
closer to each other, although
the average distance travelled
is greater than the seperate
case.

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 Framework for Network Design Decisions
Figure 5-2

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 Framework for Network Design Decisions

• Phase I: Define a Supply Chain

Strategy/Design
– Clear definition of the firm’s competitive
strategy
– Forecast the likely evolution of global
competition
– Identify constraints on available capital
– Determine growth strategy

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 Framework for Network Design Decisions

• Phase II: Define the Regional Facility

Configuration
– Approx. no. of facilities, regions where facilities will be
set up, whether a facility will produce all products of a
given market, etc
– Forecast of the demand by country or region
– Economies of scale or scope
– Identify demand risk, exchange-rate risk, political risk,
tariffs, requirements for local production, tax
incentives, and export or import restrictions
– Identify competitors

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 Framework for Network Design Decisions

• Phase III: Select a Set of Desirable

Potential Sites
– Hard infrastructure requirements
– Soft infrastructure requirements
• Phase IV: Location Choices
–Select a precise location and capacity
allocation for each facility

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 Models for Facility Location and Capacity
Allocation
• Goal is to maximize the overall profitability while
providing the appropriate responsiveness.
• Managers use network design models in two
different ways:
– Decide on locations and capacities of facilities
– Decide on the market share of each facility and
identify lanes of transportation
• Models are two types:
– Network optimization models
– Gravity models

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 Models for Facility Location and Capacity
Allocation
• Important information
– Location of supply sources and markets
– Location of potential facility sites
– Demand forecast by market
– Facility, labor, and material costs by site
– Transportation costs between each pair of sites
– Inventory costs by site and as a function of quantity
– Sale price of product in different regions
– Taxes and tariffs
– Desired response time and other service factors

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 Phase II: Capacitated Plant Location
Model
n = number of potential plant locations/capacity
m = number of markets or demand points y=i 1 if plant i is open, 0 otherwise
D j = annual demand from market j xij = quantity shipped from plant i
Ki = potential capacity of plant i to market j

f i = annualized fixed cost of keeping plant i open

cij = cost of producing and shipping one unit from plant i to market j (cost
includes production, inventory, transportation, and tariffs)

n n m
Problem:
Min f i yi   c x ij ij
There are several options
to meet the demand
i 1 i 1 j 1
-construct a small facility
subject to in each region to lower
n

x
i 1
ij  D j for j  1,..., m total transportation cost
-construct a large facility to
m lower the total construction
x
j 1
ij  K i yi for i  1,..., n cost

yi   0,1 and x ij  0, for i  1,..., n; j  1,..., m

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 Capacitated Plant Location Model
Sun Oil Company

Figure 5-4
• Vice president of Supply Chain decides to view the worldwide demand in
five regions: North America, South America, Europe, Asia, Africa
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 Capacitated Plant Location Model

Figure 5-5

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 Capacitated Plant Location Model

Figure 5-5

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 Capacitated Plant Location Model

Figure 5-6

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 Capacitated Plant Location Model

Figure 5-7

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 Phase III:Gravity Location Model
Consider the problem of locating a new facility among k facilities in supply chain.
Where should it be located, i.e., the what should be the (x,y) coordinates of this
new location?
xn, yn: coordinate location of either a market or supply source
n=1,2,...k
Fn: cost of shipping one unit for one mile between the facility and either
market or supply source n
Dn: quantity to be shipped between facility and market or supply source
(x, y) is
n the location selected for the facility, the distance dn between the
facility at location (x, y) and the supply source or market n is given by

2 2
dn = ( x – x ) +( y – y )
n n

𝑘
Total transportation  
cost to minimize =𝑇𝐶= ∑ 𝑑𝑛 𝐷 𝑛 𝐹𝑛
𝑛=1

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 Gravity Location Model
Coordinates
Transportation Cost Quantity in Tons
Sources/Markets $/Ton Mile (Fn) (Dn) xn yn
Supply sources
Buffalo 0.90 500 700 1,200
Memphis 0.95 300 250 600
St. Louis 0.85 700 225 825
Markets
Atlanta 1.50 225 600 500
Boston 1.50 150 1,050 1,200
Jacksonville 1.50 250 800 300
Philadelphia 1.50 175 925 975
New York 1.50 300 1,000 1,080
k Table 5-1
ådDF
Total transportation cost TC = n n n
n=1

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 Gravity Location Model

Figure 5-8

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 Gravity Location Model

Figure 5-8

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 Gravity Location Model
The gravity model can also be solved using the following
iterative procedure:
1. For each supply source or market n, evaluate dn
2. Obtain a new location (x’, y’) for the facility, where
k k
Dn Fn xn Dn Fn yn
å d å d
n=1 n=1
x ¢= k
n
and y¢= k
n

Dn Fn Dn Fn
å d å d
n=1 n n=1 n

3. If the new location (x’ , y’ ) is almost the same as

(x, y) stop. Otherwise, set (x, y) = (x’ , y’ ) and go to step
1

Copyright ©2013 Pearson Education. 5-28

 Phase IV: Network Optimization Models

Demand City
Production and Transportation Cost
per Thousand Units (Thousand $)
Monthly Monthly
Capacity Fixed Cost
Supply (Thousand (Thousand
City Atlanta Boston Chicago Denver Omaha Portland Units) K $) f
Baltimore 1,675 400 985 1,630 1,160 2,800 18 7,650
Cheyenne 1,460 1,940 970 100 495 1,200 24 3,500
Salt Lake 1,925 2,400 1,450 500 950 800 27 5,000
City
Memphis 380 1,355 543 1,045 665 2,321 22 4,100
Wichita 922 1,646 700 508 311 1,797 31 2,200
Monthly 10 8 14 6 7 11
demand
(thousan
d units) Dj
TelecomOne: Table 5-2
capacity 71,000 units/month; demand 32,000 units/month
HighOptic: capacity 51,000 units/month; demand 24,000 units/month
Producers of fiberoptic telecommunications equipment
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 Network Optimization Models
• Allocating demand to production facilities
n = number of factory locations (3 or 2)
m = number of markets or demand points (3 or 3) xij = quantity shipped from factory i
Dj = annual demand from market j to market j

Ki = capacity of factory i
cij = cost of producing and shipping one unit from factory i to market j

n
n m x ij  D j for j  1,..., m
Min cij xij subject to
i 1
m

x
i 1 j 1
ij  K i for i  1,..., n
j 1

Problem: Decide how markets are allocated to the facilities. Response time
should be considered.
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 Network Optimization Models
• Optimal demand allocation
Atlanta Boston Chicago Denver Omaha Portland

TelecomOne Baltimore 0 8 2

Memphis 10 0 12

Wichita 0 0 0

HighOptic Salt Lake 0 0 11

Cheyenne 6 7 0

Solve seperately: Table 5-3

TelecomOne HighOptic
Variable cost=$14,886,000 Variable cost=$12,865,000
Fixed cost=$13,950,000 Fixed cost=$8,500,000 Total Cost
Total cost=$ 28,836,000 Total cost=$ 21,365,000 =$50,201,000

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 Capacitated Plant Location Model

• Merge the companies as TelecomOptic

• Response time?
• Solve using location-specific costs
i  1,2,...,5; j  1,2,...,6
yi = 1 if factory i is open, 0 otherwise
xij = quantity shipped fromn factory i ton market
m j
Min f i yi   c x ij ij
i 1 i 1 j 1
subject to
n

x
i 1
ij  D j for j  1,..., m
m
yi   0,1 and x ij  0
 xij  K i yi for i  1,..., n
j 1
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 Capacitated Plant Location Model

Figure 5-9

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 Capacitated Plant Location Model

Figure 5-10
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 Capacitated Plant Location Model

Figure 5-10

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 Capacitated Plant Location Model

Figure 5-11

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 Capacitated Model With
Single Sourcing

Close the plants

in Salt Lake and
Wichita

Optimal total cost: $47,401,000 Figure 5-12

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 Capacitated Model With
Single Sourcing
• Each market is supplied by only one factory
• Lower complexity and less flexibility requirement from each facility
• Modify decision variables
yi = 1 if factory i is open, 0 otherwise
xij = 1 if market j is supplied by factory i, 0 otherwise
n n m
Minå f i yi + å å D j cij xij
i=1 i=1 j=1
subject to
n

åx ij
=1 for j =1,...,m
i=1
m

å Dx i ij
£K i yi for i =1,...,n
j=1

xij , yi Î { 0,1}
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 Capacitated Model With
Single Sourcing
• Optimal network configuration with single
sourcing
Open/
Closed Atlanta Boston Chicago Denver Omaha Portland
Baltimore Closed 0 0 0 0 0 0
Cheyenne Closed 0 0 0 0 0 0
Salt Lake Open 0 0 0 6 0 11
Memphis Open 10 8 0 0 0 0
Wichita Open 0 0 14 0 7 0

Table 5-4

Optimal total cost: $49,717,000

$2.3million higher than the merged case!
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 Locating Plants and Warehouses
Simultaneously

Figure 5-13

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 Locating Plants and Warehouses
Simultaneously
• Model inputs
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 warehouse 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
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 Locating Plants and Warehouses
Simultaneously
• Goal is to identify plant and warehouse locations
and quantities shipped that minimize the total
fixed and variable costs
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
n t l n t m

å å åå åå
warehouse e
Minxhi F=i yi quantity
+ f e yshipped
e
+ fromchisupplier
xie + h to factory
cej xej at
i=1 i
site e=1 h=1 i=1 e=1 j=1

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 Locating Plants and Warehouses
Simultaneously
subject to

n m

åx hi
£Sh for h =1,...,l åx ej
£We ye for e =1,...,t
i=1 j=1
l t t

åx hi
– å xie ³ 0 for i =1,...,n åx ej
=D j for j =1,...,m
h=1 e=1 e=1
t

åx ie
£ K i yi for i =1,...,n yi , ye Î { 0,1} , xej , xie , xhi ³ 0
e=1
n m

å x –å xie ej
³ 0 for e =1,...,t
i=1 j=1

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 Accounting for Taxes, Tariffs, and
Customer Requirements

• A supply chain network should maximize profits

after tariffs and taxes while meeting customer
service requirements
• Modified objective and constraint
m n n n m
Maxå rj å xij – å Fi yi – å å cij xij
j=1 i=1 i=1 i=1 j=1
n

åx ij
£D j for j =1,...,m
i=1

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 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

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 Summary of Learning Objectives
1. Understand the role of network design
in a supply chain
2. Identify factors influencing supply
chain network design decisions
3. Develop a framework for making
network design decisions
4. Use optimization for facility location
and capacity allocation decisions

Copyright ©2013 Pearson Education. 5-46

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