the role of network design in the supply chain

THE ROLE OF NETWORK DESIGN IN THE SUPPLY CHAIN

Supply chain network design decisions include the assignment of facility role location of manufacturing storage , or transportation-related facilities, and the allocation of capacity and markets to each facility.

• Facility role• Facility location• Capacity allocation• Market and supply allocation


Why is facility location so important?– Facility location has a long-term impact.– Companies can locate anywhere in the world due

to increased globalization, technology infrastructure, transportation, communications, & open markets,

– Location still matters- clusters in many industries show that innovation & competition are geographically concentrated.

– Examples?


• Network design decisions have a significant impact on performance because they determine the supply chain configuration and set constraints within which the other supply chain drivers can be used either to decrease supply chain cost or to increase responsiveness.

• Facility location decisions have a long-term impact on a supply chain’s performance because it is very expensive to shut down a facility or move it to a different location.

• In contrast, a poorly located facility makes it very difficult for a supply chain to perform close to the efficient frontier.

• Capacity allocation decisions also have a significant impact on supply chain performance

• Network design decisions must be revisited as a firm grows or when two companies merge.

FACTORS INFLUENCING NETWORK DESIGN DECISIONS

STRATEGIC FACTORS:• A firm’s competitive strategy has a significant impact on network design

decisions within the supply chain.

• Firms that focus on responsiveness tend to locate facilities closer to the market and may select a high-cost location if this choice allows the firm to react quickly to changing market needs. For example, local capacity allows the company to respond quickly to changing fashion trends in Europe. Any examples?

• Convenience store chains aim to provide easy access to customers as part of their competitive strategy.

• Global supply chain networks can best support their strategic objectives with facilities in different countries playing different roles.

• It is important for a firm to identify the mission or strategic role of each facility when designing its gobal network.


STRATEGIC FACTORS:• Offshore facility: low-cost facility for export production. Role of being a

low-cost supply source for markets located outside the country where the facility is located.

• Source facility: low-cost facility for global production. A source facility also has low cost as its primary objective, but its strategic role is broader than that of an offshore facility. Good offshore facilities migrate over time into source facilities.

• Server facility: regional production facility. A server facility’s objective is to supply the market where it is located. Examples? Pakistan?

• Contributor facility: regional production facility with development skills. A contribution facility serves the market where it is located but also assumes responsibility for product customization, process improvements, product modifications, or product development. HP in Mexico/3M in Bangalore.


STRATEGIC FACTORS:

• Outpost facility: regional production facility built to gain local skills. An outpost facility is located primarily to obtain access to knowledge or skills that may exist within a certain region

• Lead facility: facility that leads in development and process technologies. A lead facility creates new products, processes, and technologies for the entire network.


TECHNOLOGICAL FACTORS• Characteristics of available production technologies have a significant

impact on network design decisions. If production technology displays significant economics of scale, a few high-capacity locations are most effective. As a result most semiconductor companies build few high capacity facilities.

• For example, bottling plants for Coca-Cola do not have a very high fixed cost.

• Flexibility of the production technology affects the degree of consolidation that can be achieved in the network. If the production technology is very inflexible and product requirements vary from one country to another, firm has to set up local factories.


MACROECONOMICS FACTORS

Tariffs and Tax Incentives

Tariffs have a strong influence on location decisions within a supply chain.

For global firms, a decrease in tariffs has led to a decrease in the number of manufacturing facilities and an increase in the capacity of each facility built.

Taxes/Tariffs

– Several levels of government must be considered when evaluating potential locations.

– Countries with high tariffs discourage companies from importing goods into the country.

– High tariffs encourage multinational corporations to set up factories to produce locally.

– Many countries have set up foreign trade zones (FTZs) where materials are imported duty-free as long as the imports are used as inputs to production of goods.


EXCHANGE RATE AND DEMAND RISK

Fluctuations in exchange rates are common and have a significant impact on the profits of any supply chain serving global markets.

Exchange rate risks may be handled using financial instruments that limit, or hedge against, the loss due to fluctuations.

Companies must also take into account fluctuations in demand caused by changes in the economies of different countries.


POLITICAL FACTORS

Countries with independent and clear legal systems allow firm to feel that they have recourse in the courts should they need it. April 09 Dawn. Irfan Husain.

INFRASTRUCTURE FACTORSPoor infrastructure adds to the cost of doing business from a given location. Key infrastructure elements to be considered during network design include availability of sites, labor availability, proximity to transportation terminals, rail service, proximity to airports and seaports, highway access, congestion, and local utilities. What else?

COMPETITIVE FACTORSA fundamental decision firms make is whether to locate their facilities close to competitors or far from them.

FACTORS INFLUENCING NETWORK DESIGN DECISION

COMPETITIVE FACTORS

Positive Externalities b/w Firms• The result of competition is for both firms to locate close together even though doing so increases the

average distance to the customer.• Leads to development of appropriate infrastructure --- tier suppliers. Examples?

Locating to Split the Market• If firms compete on distance , they maximize share by being close to each other.• If firms compete on price and incur transportation cost to the customer, optimal to locate as far as possible

from each other.

SOCIOECONOMIC FACTORS• The industrial policy aims to spread industrialization to backward areas of the country through institutions,

appropriate initiatives and infrastructure investments that would facilitate private investment.

CUSTOMER RESPONSE TIME AND LOCAL PRESENCE• It is thus best for a convenience store chain to have many stores distributed in an area so that most people

have a convenience store close to them.

• Most towns have fewer supermarkets than convenience stores.


CUSTOMER RESPONSE TIME AND LOCAL PRESENCE (contd.)Many situations in which the presence of a facility close to a customers is important. For example, a coffee shop is likely to attract customers who live or work nearby. LOGISTICS AND FACILITY COSTSInventory and facility costs increase as the number of facilities in a supply chain increase.

When there is a significant reduction in material weight or volume as a result of processing, it may be better to locate facilities closer to the supply source rather than the customer. Examples?

For example, when iron ore is processed to make steel, the amount of output is a small fraction of the amount of ore used. Locating the steel factory close to the supply source is preferred because it reduces the distance that the large quantity of ore has to travel.

IMPORTANT FACTORS IN THE LOCATION PROCESS

A Framework forGlobal Site Location

PHASE ISupply Chain

Strategy

PHASE IIRegional Facility

Configuration

PHASE IIIDesirable Sites

PHASE IVLocation Choices

Competitive STRATEGY

INTERNAL CONSTRAINTSCapital, growth strategy,existing network

PRODUCTION TECHNOLOGIESCost, Scale/Scope impact, supportrequired, flexibility

COMPETITIVEENVIRONMENT

PRODUCTION METHODSSkill needs, response time

FACTOR COSTSLabor, materials, site specific

GLOBAL COMPETITION

TARIFFS AND TAXINCENTIVES

REGIONAL DEMANDSize, growth, homogeneity,local specifications

POLITICAL, EXCHANGERATE AND DEMAND RISK

AVAILABLEINFRASTRUCTURE

LOGISTICS COSTSTransport, inventory, coordination

5-15

FRAMEWORK FOR NETWORK DESIGN DECISIONS

Global network design decisions are made in four phases as shown in Figure 5-2. We describe each phase in greater detail.

PHASE I: DEFINE A SUPPLY CHAIN STRATEGY/DESIGN:

•Starts with a clear definition of the firm’s competitive strategy as the set of customer needs that the supply chain aims to satisfy.

–Cost efficiency? –Responsiveness? –Product Variety?–Quality?

•What managers need to look at:

–Capabilities needed to support CS–Evaluation and evolution of global competition–Constraints on available capital–Acquisitions needed


PHASE II: DEFINE THE REGIONAL FACILITY CONFIGURATION

•The objective of the second phase of network design is to identify regions where facilities will be located, their potential roles, and their approximate capacity.

•Homogenous requirements favor large consolidated facilities, whereas requirements that vary across countries favor smaller, localized facilities.

•The next step is for managers to identify whether economies of scale or scope can play a significant role in reducing costs, given available production technologies.

•If economies of scale or scope are not significant, it may be better for each market to have its own facility.

•The regional configuration defines the approximate number of facilities in the network, regions where facilities will be set up, and whether a facility will produce all products for a given market or a few products for all markets in the network.


PHASE III : SELECT A SET OF DESIRABLE POTENTIAL SITES

•Sites should be selected based on an analysis of infrastructure availability to support the desired production methodologies.

•Hard infrastructure requirements include the availability of suppliers, transportation services, communication, utilities and warehousing infrastructure, soft infrastructure requirements include the availability of skilled workforce, workforce turnover and the community receptivity to business and industry.

PHASE IV : LOCATION CHOICES

•The objective of Phase IV is to select a precise location and capacity allocation for each facility.

•Attention is restricted to the desirable potential sites selected in Phase 3.

MODELS FOR FACILITY LOCATION AND CAPACITY ALLOCATION

A manager must consider many trade-offs during network design.

Managers use network design models in two different situations. First these models are used to decide on locations where facilities will be established and the capacity to be assigned to each facility.

Second, these models are used to assign current demand to the available facilities and identify lanes along which product will be transported.

• Macroeconomic Factors:– Tariffs– Exchange Rate Fluctuations– Tax Incentives– Demand Risk– Infrastructure – Socioeconomic – Customer response time and local

presence– Competitive

• Positive externalities• Locating to split the market

– Logistics and Facility CostsWhat other factors can you think of?

PHASE II : NETWORK OPTIMIZATION MODELS

• A manager considers regional demand, tariffs, economics of scale, and aggregate factor costs to decide the regions in which facilities are to be located.

• As an example, consider SunOil, a manufacturer of petrochemical products with worldwide sales. The Vice President of Supply Chain can consider several different options to meet demand.

– Facilities at each location

– Consolidate plants in just a few regions



PHASE II : NETWORK OPTIMIZATION MODELS(Contd.)

•The disadvantages of these approaches are that plants are sized to meet local demand and may not fully exploit economies of scale. An alternative approach is to consolidate plants in just a few regions. This improves economies of scale but increases transportation cost and duties.

•During Phase II, the manager must consider these quantifiable trade-offs along with nonquantifiable factors such as the competitive environment and political risk.

•Network optimization models are useful for managers considering regional configuration during Phase II.

•In the models we consider, however, all variables costs grow linearly with the quantity produced or shipped.

•The vice president wants to know what the lowest cost network should look like.


The Capacitated Plant Location Model:

•The supply chain team’s goal is to decide on a network design that maximizes profits after taxes. For the sake of simplicity, however, we assume that all demand must be met. Taxes on earnings are ignored. Focuses on minimizing cost of meeting global demand. It can be modified to include profits and taxes.

•Looks at which region to set up a facility or facilities

•Quantitative model. Cannot consider “invisible factors” such as the competitive environment, and political risk

•Works on the premise that the following is known at an aggregate level

•Annual demand for each location

•Variable inventory costs, production and transportation costs

•Fixed costs

•The constraint in Equation 5.1 requires that the demand at each regional market be satisfied. The constraint in Equation 5.2 states that no plant can supply more than its capacity.

•The constraint in Equation 5.3 enforces that each plant is either open (yi = 1) or closed (yi = 0).

•The next step is to use Solver Tool in Excel.


The model discussed earlier can be modified to account for strategic imperatives that require locating a plant in some region. For example, if SunOil decides to locate a plant in Europe for strategic reasons, we can modify the model by adding a constraint that requires one plant to be located in Europe.

PHASE III : GRAVITY LOCATION MODELS

During Phase III (see Figure 5-2), a manager identifies potential locations in each region where the company has decided to locate a plant.

Gravity location models can be useful when identifying suitable geographic 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. Next, we discuss a typical scenario in which gravity models can be used.

Currency Stability– Impacts business costs & consequently location decisions.

Access & Proximity to Markets/Customers– “The trend in manufacturing is to be within delivery proximity of your

customers. Logistics timelines & costs are the concerns, so that reinforces a clustering effect of suppliers & producers to places that offer lower cost labor & real estate.”

– In the service industry, proximity to customers is even more critical.

Detroit's Fall Gives Power to Rival Dixie

• It's a convenient American stereotype: Detroit makes cars, Dixie races them. But as the entire tortured debate in Washington over whether to bail out the ailing U.S. auto industry has shown, that distinction is as tired and broken as the Big Three's business models. In fact, the political game of chicken that ended Friday with President Bush announcing a temporary $17 billion aid package for GM and Chrysler to stave off the immediate threat of bankruptcy has shown the rest of the country what the South has known for years: led by foreign carmakers like Toyota and Mercedes-Benz, Dixie is now Detroit's rival in auto production.

• And the foreign automakers based in the South, who account for almost a third of all cars built in the U.S., have now become the benchmark against which the Big Three are measured. As the various aid packages were being negotiated, first on Capitol Hill and then this week on the other side of Pennsylvania Avenue, one constant condition Republicans insisted upon was Detroit getting its wages and benefits down to the levels of the so-called transplant workers in states like Alabama, Tennessee, Georgia and Mississippi.

• (See pictures of the remains of Detroit.) • It was the clearest sign yet that the auto production boom has given the South not just a much-needed

industrial boost but new political leverage as well. • When Southern politicians like Alabama Senator Richard Shelby blocked a $15 billion congressional bailout

for Chrysler and GM, they gave their constituents something just as valuable as pork: some regional self-esteem, if not outright revenge. The Big Three automakers, Shelby insisted last week, "have basically failed" because of their bloated, rigid and outdated manufacturing methods, while the South's lower costs and more flexible management schemes are the new exemplar.

http://www.time.com/time/business/article/0,8599,1867907,00.html

http://www.time.com/time/photogallery/0,29307,1864272_1810098,00.html

• "Shelby is defending the industry model of his state," says Merle Black of Emory University in Atlanta, a southern politics expert. "A lot of southerners feel they've been talked down to for a long time by northern industry, so he doesn't lose any votes by doing this." Jason Ray, who has worked for both Mercedes and Chrysler in Hunstville, Ala., says the Big Three "have engineered a doomsday scenario where if they aren't allowed to continue being irresponsible with money, including the billions from taxpayers, the U.S. economy will crash. American automakers need to learn to grow with the times or become obsolete."

• More than a few northerners feel the South — supposedly the last bastion of red, patriotic values — is being hypocritical by bending over backward for Germans and Japanese at the expense of U.S. companies. To make the point, a retired GM engineer this month set up a website called boycottalabamanow.com. But southerners ask who the hypocrites really are. "When the textile industry went down in the South and we were accused of being behind the times, we didn't ask for a bailout — we just had to reinvent ourselves," says John Jeter, a South Carolina author whose family owns a small chain of auto parts stores and whose new novel, The Plunder Room, examines the modern southern character. "So southerners feel it takes some audacity for northern businessmen who make millions to come holding out beggar's bowls for billions."

• Not that southern sages like Black approve of an industrial civil war. "We're all in this recession together," says Black, who like many others is quick to note that Detroit's collapse isn't exactly good for the South, especially given the large number of auto parts production jobs that rely in part on the Big Three.

• Still, most southerners champion their region's low-tax, non-union style of economic development, which they credit for luring overseas car companies like BMW and Kia to build major plants from Kentucky to South Carolina to Texas. More important, after spending the 20th century as America's industrial backwater — and after watching the conservative Reagan revolution they once led fade away in last month's presidential election — they hail the idea that the South is rising again in the 21st century. "The sense of confidence is palpable," says Jim Cashman, a management professor at the University of Alabama and a Chicago native who has worked in the auto industry. "Companies like Mercedes have legitimized the efforts of the New South."

• Alabama has been particularly aggressive. Since the early 1990s, the state has offered German-based Mercedes, Japan's Honda and South Korea's Hyundai a staggering $1 billion in tax incentives, abatements and infrastructure improvements to build plants there. The return on investment has been $7 billion, creating almost 50,000 direct jobs and another 70,000 in sectors like parts suppliers. The population of the town of Vance, where the 4,000-employee Mercedes factory is located, has leapt from 500 to 2,000. Unlike the local sawmill, fertilizer plant or rock quarry, residents feel Mercedes "is going to survive, no matter what," says one woman who has five family members working there. "That's what made Vance what it is."

• But before Dixie gets too smug, it should acknowledge a debt it owes Detroit, or rather Detroit's labor union, the United Autoworkers (UAW). The UAW has made the Big Three's labor force one of the world's best paid and protected — clout that is now a focus of what's wrong with Detroit. Still, the foreign automakers are in America in large part because, as their more fuel-efficient cars became popular in the U.S. in the 1980s and '90s, the UAW lobbied to get them to build production plants here.

• True, those Asian and European firms flocked to the South to avoid Detroit's high-cost culture. But while southern auto employees extol the union-free, right-to-work rules of their states, the truth is that they might still be earning the basement-level wages of a Mississippi textile worker today if the UAW hadn't leaned on the likes of Mercedes in Washington. "Mercedes wanted a much lower pay scale when it arrived here," says Cashman, who notes that veteran southern autoworkers now earn "only fractionally less" than the average $27 an hour for Detroit workers (and often end up with more, thanks to the foreign car companies' bonus systems). "If not for the UAW pressure, the starting pay would have been more in line with the going wage rate of this region instead of this industry."

• At the same time, southern workers have taught the UAW an important lesson about helping to keep that industry viable. The foreign companies enjoy not only the South's lower legacy costs but a more flexible production culture. Unlike the Big Three, the southern car plants are far more agile when it comes to accommodating shifting market demand; and that's due largely to employees' willingness to exact fewer of the production rules UAW contracts are notorious for.

• Part of that efficiency is what Edward Miller, a Honda spokesman in Alabama, calls a modern "harmonious flow" — having nearby vendors supply parts, and workers assemble them, as they're needed rather than stockpiling too much inventory or flooding the market with, say, gas-guzzlers no one wants to buy anymore. "Southern communities understand you can't tie organizations down with restrictions," says manufacturing management expert David Miller of the Alabama Productivity Center. "Successful auto companies in the South provide all the positives you'd find in a union shop."

• Perhaps. But labor advocates still fear for U.S. workers if the South's automotive industry supplants Detroit as the template. And it's not as if all is as shiny as a new Lexus in Dixie right now. The Mercedes plant in Vance recently had to cut back to a four-day workweek; and with even Japanese powerhouse Toyota facing U.S. sales slumps, the company this week said it's delaying the startup of a new plant in Mississippi that will make its Prius hybrid car. Even workers like Ray now feel that a union "would definitely benefit" Dixie autoworkers; and either way, says Cashman, the New South's economies "still have many, many miles of training and education to go."

• Still, you don't hear any of the Big Three these days even thinking of opening a $1.2 billion, 2,000-employee facility in Georgia, as South Korea's Kia is set to do next year. It's enough to make a NASCAR driver take a victory lap.

OFFSHORE FACTORY

SOURCE FACTORY

SERVER FACTORY

CONTRIBUTOR FACTORY

OUTPOST FACTORY

LEAD FACTORY

the role of network design in the supply chain

Documents

located facility

source facility

facility location decisions

lowcost facility

offshore facility

contributor facility

contribution facility

supply chain cost