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SCM Network Design

Shilpa Mukesh School of Management Studies CUSAT, Kochi-22 E-mail: dhuva3@gmail.com

Abstract: The distribution function in a supply chain is an important internal service function for any firm, and has been increasingly recognized as playing a strategic role in achieving competitive advantage. Supply Chain Management encompasses the planning and management of all activities involved in sourcing and procurement, conversion, and all logistics management activities. Supply Chain spans all movement and storage of raw materials, workin-process, inventory and finished goods from the point of origin to the point of consumption. A companys supply chain comprises geographically dispersed facilities where raw materials intermediate products or finished products are acquired, transformed, stored or sold and transportation links which connect facilities along which products flow. The major decision is to design or configure the supply chain network so as to minimize annual system-wide costs including production and purchasing costs, inventory carrying costs, facility costs and transportation costs subject to a variety of customer service levels required.

Key Words: Supply Chain, Supply Chain Management, Supply Chain Network, Network Configuration.

1.0 INTRODUCTION
Supply chain management is a set of approaches utilized to efficiently integrate suppliers, manufacturers, warehouses, and stores, so that merchandise is produced and distributed at the right quantities, to the right locations, and at the right time, in order to minimize systemwide costs while satisfying service level requirements. By artificially separating supply chains from their management, it becomes evident that supply chain management is in essence an infrastructure of knowledge and information that facilitates the integrated operations of supply chains. Problems addressed by SCM are distribution network configuration, distribution strategy, information, trade offs in logistical activities, inventory management and cash flow. Organizations increasingly find that they must rely on effective supply chains, or networks, to compete in the global market and networked economy. In Peter Drucker's (1998) new management paradigms, this concept of business relationships extends beyond traditional

enterprise boundaries and seeks to organize entire business processes throughout a value chain of multiple companies.

1.1 SUPPLY CHAIN


A supply chain is a network of facilities and distribution options that performs the functions of procurement of materials, transformation of these materials into intermediate and finished products, and the distribution of these finished products to customers. Supply chains exist in both service and manufacturing organizations, although the complexity of the chain may vary greatly from industry to industry and firm to firm. Supply chain is the system of suppliers, manufacturers, transportation, distributors, and vendors that exists to transform raw materials to final products and supply those products to customers. That portion of the supply chain which comes after the manufacturing process is sometimes known as the distribution network. A supply chain is a network of facilities and distribution options that performs the functions of procurement of materials, transformation of these materials into intermediate and finished products, and the distribution of these finished products to customers.

1.2 SUPPLY CHAIN MANGEMENT


The Council of Supply Chain Management Professionals (CSCMP) defines Supply Chain Management as follows: Supply Chain Management encompasses the planning and management of all activities involved in sourcing and procurement, conversion, and all logistics management activities. Importantly, it also includes coordination and collaboration with channel partners, which can be suppliers, intermediaries, third-party service providers, and customers. In essence, supply chain management integrates supply and demand management within and across companies. Supply Chain Management is an integrating function with primary responsibility for linking major business functions and business processes within and across companies into a cohesive and high-performing business model. It includes all of the logistics management activities noted above, as well as manufacturing operations, and it drives coordination of processes and activities with and across marketing, sales, product design, finance and information technology. Supply chain management is a set of approaches utilized to efficiently integrate suppliers, manufacturers, warehouses, and stores, so that merchandise is produced and distributed at the right quantities, to the right locations, and at the right time, in order to minimize system wide costs while satisfying service level requirements. The primary objective of supply chain management is to fulfill customer demands through the most efficient use of resources, including distribution capacity, inventory and labor. In theory, a supply chain seeks to match demand with supply and do so with the minimal inventory. Various aspects of optimizing the supply chain include liaising with suppliers to eliminate bottlenecks; sourcing strategically to strike a balance between lowest material cost and transportation, implementing JIT (Just In Time) techniques to optimize manufacturing flow; maintaining the right mix and location of factories and warehouses to serve customer markets, and using location/allocation, vehicle routing analysis, dynamic programming and, of course, traditional logistics optimization to maximize the efficiency of the distribution side.

2.0 SUPPLY CHAIN NETWORKS

A firm's supply chain consists of three major parts: internal functions, upstream suppliers, and downstream customers. The internal functions include all the different processes (procurement, production, and distribution) that are used to transform raw materials to finished product. The coordination and scheduling of these processes is essential. The management of the upstream supplier network ensures that the right material is received at the right time and to the right location. The focus is on selecting a few good suppliers and maintaining a good relationship with them. The management of the downstream customer network ensures that customers receive the products they want in a timely manner. The focus is on the distribution channels that the firm employs to send the product to the end customer. Throughout the supply chain, the emphasis is on reducing inventory, hence reducing cost. The ultimate goal is customer satisfaction through delivering a quality product at a good price and in a timely fashion. The companys goal is to add value to its products as they pass through its supply chain and transport them to geographically dispersed markets in the required quantities, with correct specifications, at the required time and at a competitive cost. The facilities in the supply chain comprise of plants which are manufacturing facilities where physical product transformation takes place and distribution centers which are facilities where products are received, stored, inventoried, picked from inventory and dispatched, but not physically transformed A supply chain is often represented as a network similar to the one in figure 1.a. The flow of information or raw materials from suppliers to the manufacturer refers to upstream suppliers and manufacturer to customers denotes downstream customers. The nodes represent facilities which are connected by links that represent direct transportation connections permitted by the company in managing its supply chain. The network shown in figure 1.a has four levels of facilities. Products flow own from vendors/suppliers to manufacturing plants, manufacturers to distribution centres and from distribution centres to customers. In general, a supply chain network may have an arbitrary number of levels.

Figure 1.a: Supply Chain Network

3.0 SUPPLY CHAIN NETWORKS DESIGN


Network design addresses the issue of determining the number and types of facilities a firm will operate, where they will be located and how will operate. The supply chain network consists of suppliers, warehouses, distribution centers and retail outlets as well as raw materials, work-inprogress inventory and finished goods that flow between the facilities. Network configuration may involve issues relating to plant, warehouse and retailer locations. The key strategic\tactical decisions the supply chain manager takes while planning and designing the supply chain network are as follows: (i) Determining the number of plants. (ii) Determining the number of warehouses. (iii) Determining the size of each warehouse. (iv) Allocating space for products in each warehouse. (v) Determining which products customers will receive from each warehouse. (vi) Selection of transportation mode. (tactical) The objective is to design or configure the supply chain network so as to minimize annual system-wide costs including production and purchasing costs, inventory carrying costs, facility costs and transportation costs subject to a variety of customer service levels required. To compete effectively in the market, firms search for new ways to lower costs and improve customer service, this involves the issue of where to locate logistics and manufacturing facilities to optimize the total cost of production and distribution. In addition to enhancing the efficiency and effectiveness of a logistics operation, the proper design of a supply chain network can help to differentiate a firm in its market place.

3.1 THE PROBLEM OF NETWORK CONFIGURATION


It is concerned with specifying the structure through which products flow from their source points to demand points. There may be different configurations depending on the characteristics of products flowing through the network. This problem of network design has both spatial and temporal aspects. The spatial or geographic aspect refers to locating facilities on a geographical area (such as locating plants, warehouses and retail outlets at various geographical locations). The number, size and locations of facilities are determined by balancing the costs (production/purchase costs, inventory carrying costs, storage handling and fixed costs and transportation costs) against the requirements of customer service. The temporal problem in network planning is concerned with maintaining the product availability to meet customer service targets. Products availability may be realized through

production/ purchase order response time or through the maintenance of an inventory in the proximity of the customer. Temporal-based decisions also affect the location of facilities. Network Configuration cannot be limited to the forward movement of goods from suppliers to customers. Firms must take back from downstream locations items such as packaging materials, leased equipments, damaged goods for repair or replacement etc. This reverse network often overlays the forward network and must be integrated into it. 3.2 THE STRATEGIC IMPORTANCE OF SUPPLY CHAIN NETWORK DESIGN All business operate in a dynamic environment in which characteristics of customer demand, technology, competition, markets and suppliers are constantly changing. Because of the rate at which change is occurring, there is hardly any existing supply chain network which can be truly current or up to date. An analysis of the existing network can provide new opportunities to reduce cost and/or improve customer service. The types of change that may suggest a need to reevaluate and/or redesign a firms supply chain network are as follows:

(i) Changing customer service requirements: because of the dynamic environment,


the logistical requirements of customers are changing in many ways. This necessitates reevaluation and redesign of logistics networks for the firm to meet the demands of customers for more efficient and effective logistics service.

(ii) Shifting locations of customer and/or supply markets: because manufacturing


and logistics facilities are positioned in the supply chain between customer markets and supply markets, any changes taking place in these markets should cause a firm to reevaluate its logistics/supply chain network. In the global scene the shift in customer and supplier markets takes place more frequently and hence reconfiguring the supply chain network becomes more significant and critical to the survival of business enterprise.

(iii)Change in corporate ownership: in the present era of globalization, ownership


related changes associated with merger, acquisition or divestiture has become order of the day. It is critical to the firms to reassess their supply chain networks following ownership related changes.

(iv)

Cost pressures: in the present competitive market, a major priority for many firms is to figure out new and innovative ways to reduce cost of their business processes including those related to logistics. In such cases, a reevaluation of the supply chain network and the functioning of the supply chain can help to discover new sources of such savings.

(v) Competitive capabilities: competitive pressures may force Company to reexamine


its logistics service levels and the costs generated by its network of logistics facilities. To remain competitive in the market place, or to develop competitive advantage, it is absolutely necessary for a company to examine the relative locations of its facilities towards the goal of improving customer service and/or lowering costs.

(vi)

Corporate organizational change: any major corporate organizational change such as downsizing, calls for the review of logistics network design of the organization. In such instances, the strategic functioning of the firms logistical network must be either maintained or enhanced through the process of organizational change.

4.0 SUPPLY CHAIN NETWORK DESIGN PROCESS


The task of designing an appropriate logistics network should be closely coordinated with the identification and implementation of key corporate and overall business strategies. Step 1: Define the Supply Chain Network Design Process First, a supply chain network reengineering team is set up and entrusted with the responsibility for all elements of the supply chain network design process. Next the parameters and objectives of the supply chain network design and redesign process are established. Also the team responsible for designing the network should know about the potential involvement of logistics service providers in the achievement of the firms supply chain objectives. Step 2: Perform a Supply Chain Audit Supply chain audit provides the members of the team with a comprehensive perspective of the supply chain process. Supply chain audit helps to gather essential types of information which will be useful in the redesign process. Step 3: Examine the Supply Chain Network Alternatives Available alternatives for the supply chain network must be examined. The three principal modeling approaches are (a) optimization (b) simulation & (c) heuristic techniques. Optimization approaches search for the best solutions, simulation models replicate the functioning of the supply chain network and heuristic techniques accommodate broad problem definitions but do not provide optimum solutions. An appropriate modeling approach is selected and used to identify a supply chain network that is consistent with the key objectives identified in the previous step 2. The outcome of this step should provide a valuable set of recommendations regarding the number and general locations of logistics facilities which will help to achieve the desired objectives. Step 4: Conduct a Facility Location Analysis In the previous step, a general configuration of the desired supply chain network is developed. Next, the attributes of specific regions and cities that are candidates for sites of logistics facilities are carefully analyzed. A location selection team is formed which will collect information on specific attributes listed above. This team should be able to examine potential sites in terms of topography, geology and facility design. Step 5: Make Decisions Regarding Network & Facility Location

The alternatives developed in step 3 and 4 should be evaluated for consistency with the design criteria. The types that are needed to the firms supply chain network should be confirmed in the context of overall supply chain positioning. Step 6: Develop an Implementation Plan The final critical step is to develop an effective implementation plan. This plan should serve as a useful road map for changing the current supply chain network to the desired one. Since the reengineering process involves significant change, the firm should commit the resources necessary to assure a smooth, timely implementation.

4.1 FACTORS INFLUENCING NETWORK DESIGN DECISIONS


The factors that influence supply chain network design are classified as:

(i) Strategic factors: A firms competitive strategy has a profound impact on


the firms supply chain network decisions within the chain. Firms having the strategy of cost leadership will tend to establish their manufacturing facilities at the lowest cost locations even if these locations are far away from their markets. On the other hand firms having quick response as their strategy will tend to locate the facilities nearer to the market, even if that amounts to locating facilities at a high-cost location if this choice allows the firm to respond quickly to the changing market needs. Some of the strategic roles for various facilities in a global supply chain network are: a) b) c) d) e) f) Offshore facility Source facility Server facility Contributor facility Outpost facility Lead facility

(ii) Technological factors: supply chain network decisions are greatly


influenced by the characteristics of available production technologies. For instance, if the production technology provides significant economies of scale. If production technologies is flexible, manufacturing facilities can be consolidated in very few large facilities whereas if the production

technologies is not flexible, and product requirements vary from country to country, a firm has to set up local facilities to serve local markets in each country.

(iii)Macro economical factors: these include tariffs, taxes, exchange rate risks
and other economic factors, which are external to the firm. Tariffs refer to the duties that must be paid when a product is moved across boundaries of city, state or country. If a country charges high tariffs, then firms prefer to setup manufacturing plants in that country to avoid tariff such as custom duties imposed by the importing country. Tax incentives are tax rebates given by certain counties, states or cities to encourage firms to locate their tariffs in specific areas. Exchange rate risks occur due to fluctuations in exchange rates. Suitably designed supply chain networks help to take advantage of exchange rate fluctuations and increase profits. The flexibility in the production capacity of the firm also helps to counter fluctuations in demand across different countries.

(iv)

Political factors: firms prefer to locate their facilities in countries which have stable government and where commercial laws and other legal systems are clear and well designed. This makes it easier for the firms to invest in those countries.

(v) Infrastructural facilities: the availability of key infrastructural facilities such


as availability of good sites, labor, proximity to transportation terminals, rail service, proximity to airports, seaports, high ways and local utilities etc is an important consideration in locating a facility in a certain area.

(vi)

Competitive factors: firms must take into consideration competitors strategy, capacity and location when designing their supply chain networks.

(vii)

Logistics and facility costs: Logistics and facility costs incurred in the supply chain depend on the number of facilities, their location and capacity. The firm must consider inventory, transportation and facility costs

while designing its supply chain network. Operating costs include fixed costs and variable costs, which also are considered.

4.2 MAJOR LOCATION DETERMINANTS


The regional determinants of facility location are:

(i) Labour climate: Because of the labour-intensive nature of many logistics


operations, the cost and availability of labour becomes major issues of concern.

(ii) Availability of transportation: depending on the production type and


industry to be served, a suitable location may require inter-state highway access, availability of intermodal or local rail facilities, convenience of a major airport facility or proximity to ocean-port facility etc.

(iii)Proximity to markets and customers: the nearness to market factor


usually considers both logistics and competitive variables.

(iv)

Quality of life: the quality of life of a particular region or area affects the well being of employees and the quality of work they are expected to do.

(v) Taxes and industrial development incentives: state and local taxes which
apply to businesses and individuals as well as rebates or incentives are one of the location determinants.

(vi)

Supplier networks: for a manufacturing firm, the availability and cost of raw materials and component parts as well as cost of transporting these materials to the proposed plant site could be quite significant.

(vii)

Land costs and utilities: depending on the type of facility under consideration, the issues related to cost of land and availability of needed utilities may become critical to location decisions.

(viii)

Company preference: the top management of a firm may prefer a

certain region and/or local area for the location of a logistics facility.

5.0 A FRAMEWORK FOR NETWORK DESIGN DECISIONS


There are four phases in making global network decisions. They are: Phase 1: Defining a Supply Chain Strategy A firms supply chain strategy specifies what capabilities the supply chain network must have in order to support its competitive strategy. A firms supply chain strategy supports its competitive strategy. Supply chain strategy specifies what operations, distribution, and service would enable the firm to provide value to the customer. It includes supplier strategy, transportation strategy and logistics strategy. In this phase of network design, the firm should clearly define its supply chain strategy in terms of customer needs and how the supply chain of the firm will satisfy them. Phase 2: Defining the Configuration of Facility This phase has the objective of Identifying the regions where facilities will be located and defining their roles and capacities. The starting point is the forecast of demand countrywide which specifies the size of the demand and whether the customer requirements are homogenous or not across different countries. With the available production technologies, if a firm can exploit the benefits of economies of scale, it is better to establish few facilities to serve many large markets. Next the firm must examine the various kinds of trade barriers such as demand risk, exchange rate risk, political risk, tariffs, local production requirements, tax incentives and import/export restrictions in each region or country selected for locating the facilities. Also the competitors facility locations must be taken into consideration. Based on the above, the firm will identify the configuration of regional facilities for its supply chain network. Phase 3: Selecting Desirable Sites for Locating the Facilities In this phase, a number of alternative desirable sites are selected within each region where facilities are to be located. The major consideration in selecting the suitable sites for facility location is the analysis of availability of infrastructure to support the production technologies to be used by the firms facilities.

Phase 4: Choosing the Precise Locations for Facilities and Allocating Capacity to Each Facility. From the set of alternative sites identified for facility locations, the exact or precise location for each facility is selected and required capacity is allocated to it. The network is designed to maximize the total profits taking into consideration the expected profit margins and demand in each market. Also the various logistics and facility costs should be considered.

6.0 NETWORK DESIGN METHODS


As the very name suggests, these methods determine the location of production, stocking, and sourcing facilities, and paths the product(s) take through them. Such methods tend to be large scale, and used generally at the inception of the supply chain. The earliest work in this area, although the term "supply chain" was not in vogue, was by Geoffrion and Graves [1974]. They introduce a multi-commodity logistics network design model for optimizing annualized finished product flows from plants to the DC's to the final customers Breitman and Lucas [1987] attempt to provide a framework for a comprehensive model of a production-distribution system, "PLANETS", that is used to decide what products to produce, where and how to produce it, which markets to pursue and what resources to use. Parts of this ambitious project were successfully implemented at General Motors. Cohen and Lee [1985] develop a conceptual framework for manufacturing strategy analysis, where they describe a series of stochastic sub- models, that considers annualized product flows from raw material vendors via intermediate plants and distribution echelons to the final customers. They use heuristic methods to link and optimize these sub- models. They later give an integrated and readable exposition of their models and methods in Cohen and Lee [1988]. Cohen and Lee [1989] present a normative model for resource deployment in a global manufacturing and distribution network. Global after-tax profit (profit-local taxes) is maximized through the design of facility network and control of material flows within the network. The cost structure consists of variable and fixed costs for material procurement, production, distribution and transportation. Finally, Arntzen, Brown, Harrison, and Trafton [1995] provide the most comprehensive deterministic model for supply chain management. The objective function minimizes a combination of cost and time elements. Unique to this model was the explicit consideration of duty and their recovery as the product flowed through different countries. Implementation of this model at the Digital Equipment Corporation has produced spectacular results --- savings in the order of $100 million dollars.

Clearly, these network-design based methods add value to the firm in that they lay down the manufacturing and distribution strategies far into the future. It is imperative that firms at one time or another make such integrated decisions, encompassing production, location, inventory, and transportation, and such models are therefore indispensable .They are often difficult to solve to optimality. Furthermore, most of the models in this category are largely deterministic and static in nature. Additionally, those that consider stochastic elements are very restrictive in nature. In sum, there does not seem to yet be a comprehensive model that is representative of the true nature of material flows in the supply chain.

6.2 HUB AND SPOKE MODEL


The field of hub location started with a paper by O'Kelly (1987), who formulated a quadratic integer program for a p-Hub Median Problem (p-HMP) and showed that it was NP-hard. The p-HMP tries to find p hubs in a network of interacting nodes to minimize the overall transportation cost. The underlying assumptions are: 1 all hubs are connected 2 each spoke is assigned to a single hub 3 the hubs have unlimited capacity.

The Hub and Spoke model of Logistics is unique in its ability to deliver efficiencies and in its propensity to build in inefficiencies. Addressing these inefficiencies enables logistics service providers to gain the competitive advantage that should ideally accrue on using the hub and spoke model for logistics. The Context Let us consider the case of a logistics service provider in India handling several thousand MT of load per day across India following a Hub & Spoke Model for Distribution consisting of Hubs and Depots.

depot

depot
Hub2

Hub1

Hub4

depot depot
Hub3

Fig 2 Supply Chain Network The operations staff picks material from customer and brings it to operating unit, where the load is consolidated and sent to the attached hub in the evening. Material reaches hub from different operating units, and is segregated and sent to different hubs the same night. The delivery hub receives the material and sends it to operating unit for delivery by the operations staff. . 6.2.1 Challenges to Improving Efficiencies in a Hub and Spoke Model The hub and spoke model needs to address a unique set of challenges effectively in order for it to deliver efficiencies. These include: Internal Factors High load imbalance between different hubs An optimal network design which helped optimize cost and service level High waiting time at hubs due to process inefficiencies Load Seasonality Choice of Optimal modal mix Optimal choice of vehicle type to be used Further connectivity from Hub to depots was critical in deciding a feasible route option The prevailing vendor rates varied between hubs Lack of a route optimization tools: - Led to a mix of centralized and de-centralized mechanisms of designing new routes -Routes were designed based on individual hub requirements instead of an objective mechanism to evaluate possible alternate routes

External factors Different statutory requirements in different states such as Transit pass etc. No-entry restrictions prevailing in some key cities High waiting time at inter-state check posts Lack of adequate road infrastructure resulting in varying speed of vehicles in different sectors Objective To achieve cost and service delivery efficiencies through the design of an optimal routing model, given the high degree of complexity in distribution and high service level commitments to bemet. These can be broken down to the following metrics: Cost Optimization Metrics - Reduce cost per km per kg - Reduced Cost - Reduce load imbalance Service Delivery Metrics - Ensure less number of touch points between locations

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