CH 05

Supply Chain Management: Strategy,
Planning, and Operation

Seventh Edition, Global Edition
Chapter 5
Network Design in the
Supply Chain
Copyright © 2019 Pearson Education, Ltd.

Learning Objectives (1 of 2)
5.1 Understand the role of network design in a supply chain.
5.2 Identify factors influencing supply chain network design
decisions.
5.3 Discuss a framework for making network design decisions.
5.4 Develop an optimization model to design an regional network
configuration.

Learning Objectives (2 of 2)
5.5 Develop an optimization model to identify potential sites in a
region.
5.6 Develop an optimization model to locate plants and allocate
market demand.

The Role of Network Design (1 of 2)
• Network design decisions
– How many manufacturing plants, production lines,
distribution centers, cross-docking facilities?
– Where should facilities be located?
– How much capacity at each facility?
– Which products?
– What markets?

The Role of Network Design (2 of 2)
• Revisit design decisions after market changes, mergers, or
factor cost changes

Summary of Learning Objective 1
Network design decisions include identifying facility locations,
capacities, products handled, and allocating markets to be served
by different facilities. These decisions define the physical
constraints within which the network must operate as market
conditions change. Good network design decisions increase
profits by supporting the supply chain strategy.

Network design in SC
• Two steps:
1. Deciding on the broad structure of SC:
whether products delivered directly or via
intermediary Chap 4 of Chopra
2. Converting the broad structure into actual and Meindl
locations with specific capacity and
demand allocation Last week lecture
Chap 5 of Chopra
and Meindl
Focus of today’s
lecture

Network Design Decisions
• Facility role: e.g., manufacturing, storage, or transportation

– 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?

Factors Influencing
• STRATEGIC FACTORS Ferdows (1997) suggests the following classification of

possible strategic roles for various facilities in a global supply chain network.
1. Offshore facility: low-cost facility for export production

2. Source facility: low-cost facility for global production.
3. Server facility: regional production facility.
4. Contributor facility: regional production facility with
development skills.
5. Outpost facility: regional production facility built to gain
local skills.
6. Lead facility: facility that leads in development and
process technologies. Copyright © 2019 Pearson Education, Ltd.
Factors Influencing
• Logistics and facility costs, customer response time,

and strategic factors (last lecture)
• Technological factors and price. Example, bottling
plants of Coca-Cola are over the globe
• Macroeconomic factors
– Tariffs and tax incentives, Exchange-rate and demand risk, Freight and fuel
costs
• Political, infrastructure factors

• Competitive factors: Positive externalities between
firms, Locating to split the market
Network design decisions are influenced by non-quantifiable
factors including strategic, competitive, political, and
infrastructure. These decisions are also influenced by quantifiable
factors including desired response time and service levels, total
logistics costs, and taxes and tariffs. Network design decisions
should be checked for robustness in the face of fluctuations in
demand, costs, and exchange rates.

Framework for Network Design Decisions:
Four phases
PHASE I: SC strategy
PHASE II: Regional facility configuration

Decision tool: Capacitated Plant Location Models
PHASE III: Desirable sites

Decision tool: Gravity Location Models
PHASE IV: Location choices
Decision tools: set ofCopyright
tools © 2019 Pearson Education, Ltd.
The goal of network design is to maximize the supply chain’s long-term
profitability. The process starts by defining the supply chain strategy, which
must be aligned with the competitive strategy of the firm. The supply chain
strategy, regional demand, costs, infrastructure, and competitive environment
are used to define a regional facility configuration. For regions where facilities
are to be located, potentially attractive sites are then selected based on costs
and available infrastructure. The optimal configuration is determined from the
potential sites using demand, logistics cost, factor costs, taxes, and margins in
different markets. The robustness of the network should be checked in the
context of various risks and uncertainties faced by the supply chain. The
allocation of markets to facilities should be revised as demand and costs
change.

Models for Facility Location and
Capacity Allocation: Operations
Research Models
• Maximize overall profitability of the SC network while
providing customers with appropriate responsiveness
• Many trade-offs, constraints, and possibilities during
network design
• Network design models used to decide on locations &
capacities and to assign current demand to facilities
Many few
facilities facilities

Models for Facility Location and
Capacity Allocation: Operations
Research Model
• 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

Network Optimization Models (Phase II):
where to locate the facilities?
Example SunOil what to build (low vs high)?
• Manufacturer of petrochemical with worldwide network in five
continents
• Forecasted demand per continent (in mln of liters) per year
• Cost (inventory, production, transportation) is divided to:
1. Variable cost per mln of liters reported in 1,000$
2. Fixed annual cost (in 1,000$) and capacity (low vs high capacity)

Capacitated plant location model: problem
formulation
Input variables
Objective function (minimize
n: number of potential plant locations (5 costs):
locations)
𝑛 𝑛 𝑛 𝑚
m: number
markets)
of markets or demand points (5
∑ 𝑓𝑙 𝑖 𝑦 𝑖 +∑ 𝑓h𝑖 𝑧 𝑖 +∑ ∑ 𝑐 𝑖𝑗 𝑥 𝑖𝑗
𝑖=1 𝑖=1 𝑖=1 𝑗=1
: annual demand from market
: potential Low capacity of plant
: potential High capacity of plant Fixed cost Variable
: annualizedfixed cost of keeping plant i of low Subject to (constraints):
capacity open n
: annualized fixed cost of keeping plant i of high x ij  D j for j
capacity open i 1
m
: cost of producing and shipping one unit from
plant i to
Decision market j
variables x
j 1
ij  KLi yi  KH i zi i
:1 if low capacity plant is open in loi, 0
otherwise yi , zi  0,1 for i, x ij  0
:1 if high capacity plant is open in i, 0 otherwise
: quantity shipped from plant in loc. i to market j
Capacitated plant location model:
Implementation in Excel solver
Solver is an Add-In in Excel that you need to activate to start using it. How to do see the
link in the margin below. Steps:
1. Define the cells corresponding with the decision

variables , , and . Add some initial values
2. Define a cell for the objective function (it should
contain an Excel formula)
3. Setup the solver by adding the constraints and
selecting the cell of the objective function

Capacitated Plant Location Model:
Defining decision variables (Step 1)
j=1 j=2 j=3 j=4 j=5 Low cap. High cap.
i=1
i=2
i=3
i=4
i=5
𝑥𝑖𝑗 𝑦 𝑖 Copyright
𝑧 𝑖 © 2019 Pearson Education, Ltd.
Constraints and objective (Step 2)
𝑚
No plant can supply 𝐾 𝐿𝑖 𝑦 𝑖 + 𝐾 𝐻 𝑖 𝑧 𝑖 − ∑ 𝑥 𝑖𝑗 ≥ 0
more than capacity 𝑗=1
𝑛
Unmet demand should 𝐷 𝑗 −
be zero
∑ 𝑥𝑖𝑗 =0
𝑖=1
Constraints and objective (Step 2)
𝑛 𝑛 𝑛 𝑚
∑ 𝑓𝑙 𝑖 𝑦 𝑖 + ∑ 𝑓h𝑖 𝑧 𝑖 + ∑ ∑ 𝑐 𝑖𝑗 𝑥 𝑖𝑗
𝑖 =1 𝑖 =1 𝑖 =1 𝑗=1

Capacitated Plant Location Model: Add
constraints & objective in Excel Solver
(Step 3)
Excel Demo!
SunOil Excel
sheets will be
uploaded to
Blackboard

Capacitated Plant Location Model: results
If SunOil for
strategic reason
decides to
locate a plant in
EU, what to do
in this case?
If I have a
condition that a
market is
supplied from
only one plant,
what shall you
do? Education, Ltd.
Copyright © 2019 Pearson
The capacitated plant location model can be used to obtain a
regional configuration that minimizes total cost or maximizes
total profits. The model provides optimal plant locations while
ensuring that no plant supplies more than its capacity and each
market obtains enough supply to meet demand.

Gravity Location Model (where to locate
the facility?)
 Gravity model is useful when identifying suitable location

of the facility within a region that minimizes the cost of
transportations of raw materials from a supplier and
finished goods to the markets.
 First input is the location of suppliers and markets

Gravity Location Model (Phase III):
problem formulation
What type of problem do
Input data we have LP, MILP, NLP?
 xn, yn: coordinate location of either a supplier or
market n
 Fn: cost of shipping one unit for one mile between
the facility and either market or supplier n
 Dn: quantity (demand) to be shipped between
facility and market or supply source n
Decision variables
 x, y: the location selected for the plant
Objective
 Minimize total transportation costs
Auxiliary variables
 d : distance the facility at location (x, y) and the
Gravity Location Model: Example Steel
Appliances
Coordinates
Sources/ Transportation Cost Quantity in Tons
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
Minimize total transportation costs
Gravity Location Model: Solving Steel
Appliances problem using Excel
Step1. Define cells to the

decision variables x,y
(location of plant)
Step 2. Define cells to the
auxiliary variables
Step 3. Define cell to the
objective function total
costs
Step 4. set the solver to
minimize the objective
function by changing the What solving algorithm we need
decision variables. to choose in the Excel Solver?
Gravity Location Model: Solving Steel
Appliances problem using Excel
 Optimal location of facility is at (681,882) which is a

region around Virginia at costs 1,265,235$
 Virgina is not appropriate because it doesn’t have a good
infrastructure and appropriate workers. Manager should
look for the best region around Virginia that satisfies the
requirements
 The optimal location x-coordinate is the weighted
average of xn-coordinates with weight Fn*Dn/dn (same
holds for y-coordinate) Copyright © 2019 Pearson Education, Ltd.
Gravity Location Model: Iterative
algorithm
1. We set x=0 and y=0

2. For each supply source or market n, evaluate dn
3. Obtain a newk location (x’, y’) for kthe facility, where
Dn Fn xn Dn Fn yn
 dn
 dn
x  n 1k and y   n 1k
Dn Fn Dn Fn

n 1 d

n 1 d n
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 2

Network Optimization Models: Allocating
demand to facilities
 Given that the manager has different plants how to allocate the
capacities to the different market
 Two companies example are operating independently
Demand City: red supplied from comp. 1, black from comp.
2
Production and Transportation Cost
per Thousand Units (Thousand $)
Monthly Monthly
Capacity Fixed Cost
Supply Chicag (Thousand (Thousand
City Atlanta Boston o 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
Copyright 31 Education,
© 2019 Pearson 2,200Ltd.
The gravity model can be used to identify potential facility
locations in each region. Given the quantity coming from supply
sources and market demand, the model identifies the geographic
location in a region that minimizes the total transportation cost.
This geographic location can be used to identify nearby potential
sites that satisfy both hard and soft infrastructure requirements.

Network Optimization Models
• Allocating demand to production facilities. Solving to independent problem
= number of factory locations

= number of markets or demand points xij = quantity shipped from
= annual demand from market j factory i to market j
= capacity of factory i
= cost of producing and shipping one unit from factory i to market j
subject to n
x
i 1
ij  D j for j  1,..., m
m
x
j 1
ij  K i for i  1,..., n

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
• Optimal costs
– Red company 28,836,000$ (incl. fixed costs)
Table 5-3
– Blue company 21,365,000$ (incl. fixed costs)
Total: $50 mln

Capacitated Plant Location Model
• Should we merge the network of two companies? Should red company keeps Wichita?
• Solve using location-specific costs
yi = 1 if factory i is open, 0 otherwise

xij = quantity shipped from factory i to market j


Figure 5-11

What shall
you do as a
management
team in this
Savings is Copyright
around© 8% case?
2019 Pearson Education, Ltd.
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

More Complex Capacitated Plant Location
Model (1 of 2)
• Capacitated plant location model with single sourcing
yi = 1 if factory i is located at site i, 0 otherwise

xij = 1 if market j is supplied by factory i, 0 otherwise
n n m
Min  fi y i   D c x j ij ij
i 1 i 1 j 1
Subject to
n
x
i 1
ij  1 for j  1, ,m
m
D x
j 1
j ij  K i y i for i  1, ,n
xij ,y i  0,1
More Complex Capacitated Plant Location
Model (2 of 2)
Table 5-3 Optimal Network Configuration for TelecomOptic
with Single Sourcing
Blank 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

Locating Plants and Warehouses
Simultaneously (1 of 5)
Figure 5-13 Stages in a Supply Network

• 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 market j
Ki = potential capacity of factory at location l
Sh = supply capacity at supplier h

We = potential warehouse capacity at location e
Fi = fixed cost of locating plant at location l
fe = fixed cost of locating a warehouse at location e
chi = cost of shipping one unit from supply source h to factory l
cie = cost of producing and shipping one unit from factory l to
warehouse e
cej = cost of shipping one unit from warehouse e to market j

• Decision variables
yi = 1 if factory is located at location i, 0 otherwise

ye = 1 if factory is located at location e, 0 otherwise
xej = quantity shipped from warehouse e to market j
xie = quantity shipped from factory at location i to
warehouse e
xhi function
• Objective = quantity shipped from supplier h to factory at
location
n
i t l n n t t m
Min  Fi y i   fe y e   chi xhi   cie xie   cej xej
i 1 e 1 h 1 i 1 i 1 e 1 e 1 j 1

• Constraint equations
n m
x
i 1
hi  Sh for h  1, ,l x ej  We y e for e = 1, ,t
j 1
l t
x   xie  0 for i  1, ,n

t
h 1
hi
e 1
x
e 1
ej  D j for j = 1, ,m
y i ,y e  0,1,xej ,xie ,xhi  0

t
x
e 1
ie  K i y i for i  1, ,n
n m
x x
i 1
ie
j 1
ej  0 for e  1, ,t

The capacitated plant location model can be used to locate
production facilities and warehouses to minimize total network
costs or maximize network profits. A similar model can also be
used to allocate market demand across an existing set of facilities
in a supply chain network. Both models optimize the objective
function while ensuring that capacity constraints are satisfied and
market demand is served.

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Supply Chain Management: Strategy,

Planning, and Operation

Copyright © 2019 Pearson Education, Ltd.

Copyright © 2019 Pearson Education, Ltd.

Copyright © 2019 Pearson Education, Ltd.

Copyright © 2019 Pearson Education, Ltd.

Copyright © 2019 Pearson Education, Ltd.

Copyright © 2019 Pearson Education, Ltd.

Copyright © 2019 Pearson Education, Ltd.

• Facility role: e.g., manufacturing, storage, or transportation

• Market and supply allocation

Copyright © 2019 Pearson Education, Ltd.

• STRATEGIC FACTORS Ferdows (1997) suggests the following classification of

1. Offshore facility: low-cost facility for export production

• Logistics and facility costs, customer response time,

• Political, infrastructure factors

Copyright © 2019 Pearson Education, Ltd.

PHASE II: Regional facility configuration

PHASE III: Desirable sites

Copyright © 2019 Pearson Education, Ltd.

Copyright © 2019 Pearson Education, Ltd.

Copyright © 2019 Pearson Education, Ltd.

Copyright © 2019 Pearson Education, Ltd.

1. Define the cells corresponding with the decision

Copyright © 2019 Pearson Education, Ltd.

j=1 j=2 j=3 j=4 j=5 Low cap. High cap.

Copyright © 2019 Pearson Education, Ltd.

Copyright © 2019 Pearson Education, Ltd.

Copyright © 2019 Pearson Education, Ltd.

 Gravity model is useful when identifying suitable location

Copyright © 2019 Pearson Education, Ltd.

Step1. Define cells to the

 Optimal location of facility is at (681,882) which is a

1. We set x=0 and y=0

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

Copyright © 2019 Pearson Education, Ltd.

Copyright © 2019 Pearson Education, Ltd.

• Allocating demand to production facilities. Solving to independent problem

= number of factory locations

Copyright © 2019 Pearson Education, Ltd.

• Optimal demand allocation

Atlanta Boston Chicago Denver Omaha Portland

HighOptic Salt Lake 0 0 11

Total: $50 mln

Copyright © 2019 Pearson Education, Ltd.

• Solve using location-specific costs

yi = 1 if factory i is open, 0 otherwise

Copyright © 2019 Pearson Education, Ltd.

Copyright © 2019 Pearson Education, Ltd.

Copyright © 2019 Pearson Education, Ltd.

• 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

Copyright © 2019 Pearson Education, Ltd.

yi = 1 if factory i is located at site i, 0 otherwise

Blank Open/Closed Atlanta Boston Chicago Denver Omaha Portland

Copyright © 2019 Pearson Education, Ltd.

Figure 5-13 Stages in a Supply Network

Copyright © 2019 Pearson Education, Ltd.

Copyright © 2019 Pearson Education, Ltd.

Copyright © 2019 Pearson Education, Ltd.