Network Design in the Supply

chain
 The Role of Network Design in the Supply Chain
A supply chain is a network of facilities and the location of production facilities,
distribution centers, and retail sites determines the efficient flow of goods to and from
these facilities.
Supply chain network design decisions are classified as follows:
1. Facility role: What role should each facility play? What processes are performed at
each facility?
2. Facility location: Where should facilities be located?
3. Capacity allocation: How much capacity should be allocated to each facility?
4. Market and supply allocation: What markets should each facility serve? Which
supply sources should feed each facility?
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.
• Decisions regarding the role of facility is significant because they determine the
amount of flexibility the supply chain has in changing the way it meets demand.

• Facility location decisions have a long-term impact on a supply chain’s performance

because it is expensive to shut down a facility or move it to a different location and
also it can help a supply chain be responsive while keeping the cost low.

• Capacity allocation decisions do tend to stay in a place for longer duration.

Allocating to much capacity to a location results in poor utilization and higher cost.
Allocating little capacity results in poor responsiveness if demand is not satisfied.

• The allocation of supply resources and markets to facilitates has a significant impact
on performance because it affects the total production, inventory and transportation
costs incurred by the supply chain to satisfy the customer demand.
 Factors Influencing the Network Design Decisions
we examine a wide variety of factors that influence network design decisions in
supply chains:
a. Strategic Factors:
• A firm’s competitive strategy has a significant impact on network design decisions
within the supply chain. Firms that focus on cost leadership tend to find the lowest
cost location for their manufacturing facilities, even if that means locating far from
the markets they serve.
• In contrast, 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.
• Zara, the Spanish apparel manufacturer, has a large fraction of its production
capacity in Portugal and Spain despite the higher cost there. The local capacity
allows the company to respond quickly to changing fashion trends. This
responsiveness has allowed Zara to become one of the largest apparel retailers in the
world.
Factors Influencing the Network Design Decisions

• Convenience store chains aim to provide easy access to customers as part of

their competitive strategy. Convenience store networks thus include many
stores that cover an area, with each store being relatively small.

• Discount stores such as Walmart use a competitive strategy that focuses on

providing low prices. Thus, their networks have large stores, and customers
often have to travel many miles to get to one..
Factors Influencing the Network Design Decisions

b. Technological Factors:
• Available production technologies have a significant impact on network design
decisions. If production technology displays significant economies of scale, a
few high-capacity locations are most effective.
• This is the case in the manufacture of computer chips, for which factories
require a large investment and the output is relatively inexpensive to transport.
As a result, most semiconductor companies build a few high-capacity facilities.
• In contrast, if facilities have lower fixed costs, many local facilities are
preferred because this helps lower transportation costs. For example,
bottling plants for Coca-Cola do not have a high fixed cost. To reduce
transportation costs, Coca-Cola sets up many bottling plants all over the world,
each serving its local market.
Factors Influencing the Network Design Decisions
c. Tariffs and Tax Incentive:
• Tariffs refer to any duties that must be paid when products and/or equipment are
moved across international, state, or city boundaries. Tariffs have a strong
influence on location decisions within a supply chain. If a country has high
tariffs, companies either do not serve the local market or set up manufacturing
plants within the country to save on duties.
• High tariffs lead to more production locations within a supply chain network,
with each location having a lower allocated capacity.
• Tax incentives are a reduction in tariffs or taxes that countries, states, and cities
often provide to encourage firms to locate their facilities in specific areas.
• Developing countries often create free trade zones in which duties and tariffs are
relaxed as long as production is used primarily for export. This creates a strong
incentive for global firms to set up plants in these countries to be able to exploit
their low labor costs
Factors Influencing the Network Design Decisions

d. Freight and Fuel Cost.

e. Political Factor.

f. Infrastructure Factor.

g. Competitive Factors.
 Models for Supply Chain Network Design
• A manager’s goal is to maximize the overall profitability of the resulting supply chain
network when locating facilities and allocating capacities.
• Managers use network design models in two situations:
 First, these models are used to decide on locations where facilities will be established and
determine the capacity to be assigned to each facility.
 Second, these models are used to assign current demand to the available facilities and identify
the which product will be transported.
• Relevant Costs for Network Design:-
Three types of costs are important for network design and operations related
decisions:-
a. Fixed Facility Cost.
b. Variable Production Cost.
c. Transportation Cost.
 Network Design and Operations Models
• Network Operations Planning-
Given a fixed network design, it is possible to plan and execute network operations in such a
manner so as to minimize the cost. This is achieved primarily by solving the demand allocation
problem.
Cost Minimization Model:

The firm has to allocate the demand from different markets to different plants. Let
• Since, the firm likes to minimize the total cost, its objective function will be

Subject to the following constraints:

The first constraint equation ensure that the demand at each of the market place is satisfied
and the second constraint equation ensure that production at each factory does not violate
the capacity of the plant.
 Profit Maximization Model:
A firm might solve the profit maximization problem, where the objective function includes
a term for revenue, which is obtained by multiplying the volume of shipment to markets
with their respective price. Basically we want to maximize the contribution
The objective function is

The demand specified by the marketing department becomes the upper bound.
Example
• Let us took a hypothetical company, Indian Paints, a paint manufacturing firm, which has
four manufacturing plants located at Ahmadabad, Hubli, Nagpur, and Vishakapatnam. The
firm has recently added one more plant at Baddi in Himachal Pradesh because of
attractive tax concessions available there. The firm primarily operates in six major
markets. The marketing group prepares market estimates every quarter and expects the
supply chain to plan its operations so that the firm can deliver its products to all six
markets at the lowest possible costs.
Plant Capacity Fixed Facility Cost Unit Variable
Production Cost
Ahmadabad 350 78,000 675
Baddi 400 42,000 525
Hubli 450 36,000 650
Nagpur 300 38,000 625
Vishakapatnam 400 34,000 675
Market Data
Market Bangalore Chennai Delhi Mumbai Lucknow Kolkata
Quarterly 165 135 280 200 125 155
demand
Price per 1030 950 1000 975 900 850
unit

Transportation Cost Matrix

Bangalore Chennai Delhi Mumbai Lucknow Kolkata

Ahmadabad 235 278 100 65 189 261

Baddi 511 558 97 328 216 305
Hubli 77 138 327 105 372 326
Nagpur 165 160 183 117 148 235
Vishakapatnam 163 107 328 217 303 203
Production plus Transportation Cost Matrix

Bangalore Chennai Delhi Mumbai Lucknow Kolkata

Ahmadabad 910 953 775 740 864 936

Baddi 1036 1083 622 853 741 830
Hubli 727 788 977 755 1022 976
Nagpur 790 785 808 742 773 860
Vishakapatnam 838 782 1003 892 978 878
• Cost Minimization Model:
Using Excel Solver, we get the following financial performance for Indian Paints:
Revenue = 1,017,450
Variable Cost = 773,770
Gross Profit = (Revenue – variable cost) = 1,017,450 – 773,770 = 243,680
Net Profit = (Gross Profit – Fixed Cost) = 243,680 – 228,000 = 15,680.

Bangalore Chennai Delhi Mumbai Lucknow Kolkata Supply

Ahmadabad 0 0 0 200 0 0 200
Baddi 0 0 280 0 120 0 400
Hubli 165 0 0 0 0 0 165
Nagpur 0 0 0 0 5 155 160
Vishakapatnam 0 135 0 0 0 0 135
Demand Net 165 135 280 200 125 155 1060
• Profit Maximization Model:
Using Excel Solver, we get the following financial performance for Indian Paints:
Revenue = 885,700, Variable cost = 640,470
Gross Profit = (Revenue – Variable Cost) = (885,700 – 640,470) = 245,230
Net Profit = Gross Profit – Fixed Cost = 245,230 – 228,000 = 17,230

Bangalore Chennai Delhi Mumbai Lucknow Kolkata Supply

Ahmadabad 0 0 0 200 0 0 200
Baddi 0 0 280 0 120 0 400
Hubli 165 0 0 0 0 0 165
Nagpur 0 0 0 0 5 0 160
Vishakapatnam 0 135 0 0 0 0 135
Demand Net 165 135 280 200 125 0 905
• Some Observations-
1. It is not profitable for Indian paints to serve Kolkata market. So even the firm has a
lower top line, it has higher profits and the profit has increased by almost 10 percent.

2. Variable cost is also reduced significantly from the previous model.

3. You cannot supply more than the volume specified by the marketing group.

4. If the market is not profitable or the company has supply problems, company may
decide not to serve that market.
• Network Design Problem-
• Over a period of time the market structures might change.
For example, market demand in South India may increase at a faster pace or
the cost structures may change significantly.
• Change in wages, utilities or transport cost alters the competitiveness of different
plants.
• A firm may find new locations more attractive and might like to add capacities in
these new emerging areas.
 Firms use network design models for rationalizing facilities due to the above
causes.
• Consider the same example of Indian paints. Let us assume that the firm decides to
rationalize network design because it has surplus capacity in the network.

• As the firm has excess capacity and fixed costs account for a significant part of costs, the
firm may explore the idea of closing some facilities so as to save some fixed costs in the
process.

• Now the firm has to first decide whether to keep the plants open or closed, supply being
possible only from the plants that are open.

• If a plant is closed or not opened, the firm does not incur any fixed cost on that plant. So
we make a modification in the model and introduce a binary variables, which we can take
values either 0 or 1.
Network Design Model: Cost Minimization Model
If a firm wants to work with an objective of cost minimization for the network, the revised
objective function:
• Network Design Model: Cost Minimization Model
Using Excel Solver, we get the following values
Revenue =1,017,450
Net Profit = (Revenue – Fixed Cost-Variable Cost) = (1,017,450-892585) = 124865

Bangalore Chennai Delhi Mumbai Lucknow Kolkata Supply Plant (O/C)

Ahmadabad 0 0 0 0 0 0 0 Close
Baddi 0 0 280 0 120 0 400 Open
Hubli 165 0 0 200 0 0 365 Open
Nagpur 0 0 0 0 0 0 0 Close
Vishakapatnam 0 135 0 0 5 155 295 Open

Demand Net 165 135 280 200 125 155

• Some Observations:
1. The results suggests that Ahmedabad and Nagpur plants should be closed.

2. Ahmedabad has significantly high fixed cost and Nagpur has relatively lower volume of
allocation.

3. Compare with cost minimization model (Network Operations Planning), this model
leads to an increase in the net profit, despite the increase in the total variable cost.
 Network Design Model: Profit Maximization Model
If the network design problem is solved as a profit maximization problem (all markets need
not be served), the objective function will be as follows:
• Network Design Model: Profit Maximization Model
Using Excel Solver, we get the following results-
Revenue = 833,700
Variable Cost = 601,015
Gross Profit = (Revenue – Variable Cost) = (833,700 – 601,015) = 232,685
Net Profit = (Gross Profit – Fixed Cost) = (232,685 – 78,000) = 154,685
Bangalore Chennai Delhi Mumbai Lucknow Kolkata Supply Plant (O/C)

Ahmadabad 0 0 0 0 0 0 0 Close
Baddi 0 0 280 0 120 0 400 Open
Hubli 165 85 0 200 0 0 450 Open
Nagpur 0 0 0 0 0 0 0 Close
Vishakapatnam 0 0 0 0 0 0 0 Close

Demand Net 165 135 280 200 125 0

• Some Observations
• This suggests that the Ahmedabad, Vishakapatnam, and Nagpur plants should be closed.
• The Ahmedabad plant has significantly high fixed cost and Vishakapatnam plant has
relatively lower volume of allocation.
• Further it is not necessary to serve the Kolkata market, the Nagpur facility can also be
closed to save the relevant fixed cost.
• Comparing with the profit maximization model (Network Operations), this model leads to
decrease in revenue and variable costs. Thus reduction in gross profit.
• But due to low fixed cost, the net profit is increased.
Example
• Consider SunOil, a manufacturer of petrochemical products with worldwide sales. The vice
president of supply chain is considering several options to meet the demand. One possibility is to
set up a facility in each region. The advantage of such an approach is that it lowers transportation
cost and also helps avoid duties that may be imposed if product is imported from other regions.
The disadvantage of this approach is that the plants are sized to meet the local demand and may
not fully exploit the economies of scale. Another approach is to consolidate plants in just a few
regions. This imposes economic of scale but increases transportation cost.
Production and Transportation cost per 1,000,000 units Fixed Low Fixed Cost High
Cost ($) Capacity ($) Capacity
Supply N. America S. America Europe Asia Africa

N. America 81 92 101 130 115 6000 10 9000 20

S. America 117 77 108 98 100 4500 10 6750 20

Europe 102 105 95 119 111 6500 10 9750 20

Asia 115 125 90 59 74 4100 10 6150 20

Africa 142 100 103 105 71 4000 10 6000 20

Demand 12 8 14 16 7

Cost Data (in Thousand of Dollars) and Demand Data (in Millions of Units)
Location Plant and Warehouse simultaneously
 Location Plant and Warehouse simultaneously

• The goal is to identify plant and warehouse locations, as well as quantities shipped
between various points, that minimize the total fixed and variable costs.
Define the following decision variables:
= 1 if factory is located at site i, 0 otherwise
= 1 if warehouse is located at site e, 0 otherwise
= quantity shipped from warehouse e to market j
= quantity shipped from factory at site i to warehouse e
= quantity shipped from supplier h to factory at site I
The objective function