The Value of Supply Chain Network Design
- What Is Supply Chain Network Design and Why Is It Important?
- Quantitative Data: Why Does Geography Matter?
- Quantitative Data: Why Have Warehouses?
- Quantitative Data: Why Have Multiple Plants?
- Solving the Quantitative Aspects of the Problem Using Optimization
- Data Precision Versus Significance: What Is the Right Level in Modeling?
- Nonquantifiable Data: What Other Factors Need to Be Considered?
- Nonquantifiable Data: What Are the Organizational Challenges?
- Where Are We Going with the Book?
- End-of-Chapter Questions
What Is Supply Chain Network Design and Why Is It Important?
A firm’s supply chain allows it to move product from the source to the final point of consumption. Leading firms around the world, from large retailers to high-tech electronics manufacturers, have learned to use their supply chain as a strategic weapon. A supply chain is defined by the suppliers, plants, warehouses, and flows of products from each product’s origin to the final customer. The number and locations of these facilities is a critical factor in the success of any supply chain. In fact, some experts suggest that 80% of the costs of the supply chain are locked in with the location of the facilities and the determination of optimal flows of product between them. (This is similar to the notion from manufacturing that you lock in 80% of the cost to make a product with its design.) The most successful companies recognize this and place significant emphasis on strategic planning by determining the best facility locations and product flows. The discipline used to determine the optimal location and size of facilities and the flow through the facilities is called supply chain network design.
This book covers the discipline of supply chain network design. Sometimes it is referred to as network modeling because you need to build a mathematical model of the supply chain. This model is then solved using optimization techniques and then analyzed to pick the best solution. Specifically, we will focus on modeling the supply chain to determine the optimal location of facilities (warehouses, plants, lines within the plants, and suppliers) and the best flow of products through this facility network structure.
Here are four examples to illustrate the value of supply chain network design.
Often, we hear about firms acquiring or merging with another firm in the same industry to reduce the overall costs to operate both firms. That is, they justify the new combined company by determining that they can deliver the same or more products to the market at an overall lower cost. In firms that make or ship a lot of products, a large portion of the savings comes from the merger of the two supply chains. In such mergers, the savings often come from closing redundant plant and warehouse locations, opening new plants and warehouses, or deciding to use existing facilities to make or distribute different mixes of product. We have heard firms claim resultant supply chain savings from $40 million to $350 million over a period of a couple of years. With these kinds of savings, you can only imagine the pressure placed on the supply chain team to determine the new optimal supply chain structure after an acquisition or merger is announced.
Often, a large firm will find that its supply chain no longer serves its business needs. In situations like this, the firm will have to transform its supply chain. It may have to close many facilities, open many new ones, and use facilities in a completely different way. For example, a retail firm may have to redesign their supply chain to serve their stores as well as their new online customer base in a more integrated approach. Or a large retailer may find that some of their product lines have grown significantly and the retailer needs new warehouses to manage this growth. If done right, this type of supply chain transformation can help reduce logistics and inventory costs, better respond to different competitive landscapes, and increase sales and profitability. We have even seen firms highlight this work in their annual reports, therefore showing the importance of this analysis to the firm as a whole.
In the spring of 2011, we were working on a project for a global chemical company to help develop their long-term plan for their supply chain. This study was analyzing where they should locate new plants to serve a global customer base. The long-term project suddenly became extremely short-term when the CEO called the project team to inform them that within six hours they were closing their plant in Egypt due to political unrest. He also indicated there was no timeline for reopening the plant. The CEO immediately needed to know which of the existing plants should produce the products that were currently being manufactured in Egypt and how customer demand was going to be impacted. The team was quickly able to deliver the answers and minimize this supply chain disruption. As seen in this example, supply chain network design models can also be a great tool for identifying risks and creating contingency plans in both the short and long term.
As consumer behavior and buying patterns change, firms often want to bring their product to the market through different channels. For example, we worked with a consumer products company that wanted to analyze different channels such as selling through big-box retailers, selling through smaller retailers, selling direct online, and selling through distributors. This firm wanted to analyze different ways to bring their product to market and understand what the supply chain would need to look like for each of these cases. That is, they wanted to determine the optimal number and location of plants and warehouses. This would then be a key piece of information to help them determine their overall strategy.
Of course, the details of these studies can be a bit more complicated. As an example, take a minute to think through the possible supply chain for a tablet computer and compare that to the supply chain you envision for a candy bar.
The tablet supply chain faces specific challenges surrounding a time-sensitive delivery of the device for a very demanding high-tech customer market. The tablet maker must also determine how to best balance its partnerships with many contract manufacturers worldwide while still ensuring the highest quality end products. Finally, this supply chain must deal with the high costs for insurance, transport, and storage of these high-priced finished goods.
Conversely, when we shift our thoughts to the supply chain related to the candy bar, we must consider an entirely different set of challenges and objectives that the candy maker must face: government regulations that mandate different requirements for all stages of production paired with a strict shelf life of each unit produced. In addition, raw material costs, as well as costs tied to temperature control during transit and storage, add up. Major swings in demand due to seasonality or promotions also add the need for flexibility within their supply chain.
Despite their differences, both the tablet maker and candy bar maker must determine the best number and location of their suppliers, plants, and warehouses and how to best flow product through the facilities. And building a model using optimization is still the best way for both of them to determine their network design.
As the previous examples highlight, many different types of firms could benefit from network design and many factors go into the good design of the supply chain. Along with ever-growing complexity, the need to truly understand how all these requirements affect a company’s costs and performance is now a requirement. Using all these variables to prove out the optimal design configuration commonly saves companies millions of dollars each year.
As you would expect, a network design project can answer many types of questions such as these:
- How many warehouses should we have, where should they be, how large should they be, what products will they distribute and how will we serve our different types of customers?
- How many plants or manufacturing sites should we have, where should they be, how large should they be, how many production lines should we have and what products should they make, and which warehouses should they service?
- Which products should we make internally and which should we source from outside firms?
- If we source from outside firms, which suppliers should we use?
- What is the trade-off between the number of facilities and overall costs?
- What is the trade-off between the number of facilities and the service level? How much does it cost to improve the service level?
- What is the impact of changes in demand, labor cost, and commodity pricing on the network?
- When should we make product to best manage and plan for seasonality in the business?
- How do we ensure the proper capacity and flexibility within the network? To meet demand growth, do we need to expand our existing plants or build new plants? When do we need to add this capacity?
- How can we reduce the overall supply chain costs?
Being able to answer these questions in the optimal manner is important to the overall efficiency and effectiveness of any firm. Companies that have not evaluated their supply chain in several years or those that have a new supply chain through acquisitions can expect to reduce long-term transportation, warehousing, and other supply chain costs from 5% to 15%. Many of these firms also see an improvement in their service level and ability to meet the strategic direction of their company.
Although firms are happy to find 5% to 15% reduction in cost, it does highlight that your supply chain might have already missed out on significant savings you may have realized had you done the study a year ago (or two or more years ago). Some firms have realized this and now run this type of analysis on a more frequent basis (say, quarterly). This allows them to readjust their supply chain over time and keep their supply chain continually running in an optimal state while preventing costs from drifting upward.
The frequency of these studies depends on several factors. Historically, it has been customary to complete these analyses once every several years per business unit, because it was usual for business demographics and characteristics to change over this period of time. For some industries such as high-tech, the frequency was even higher because there may be higher volatility in customer demand, thereby requiring periodic reevaluation of the network. Any major events, such as mergers, acquisitions, or divestitures, should also trigger a network reevaluation study. As noted before, the savings from the optimization of the revised network typically represent a significant part of the savings that justify the merger or divestiture. A current trend we are seeing, however, is to do these studies even more frequently. Business demographics and characteristics are changing faster. In addition, the growth of the global supply chain is driving firms to cycle through studies as they go from region to region around the world. Also, firms are running the same models more frequently to stay on top of changes in their business by adjusting the supply chain. Some firms update these models several times throughout the year.
Determining the right supply chain design involves a lot of quantitative data as well as some nonquantitative considerations. We will discuss this in the rest of this chapter, as well as how we use mathematical optimization to sort through this quantitative data.