SC Design Facility Location

Sections 4.1, 4.2 Chapter 5 and 6

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Outline
Frequency decomposition of activities x A strategic framework for facility location x Multi-echelon networks x Analytical methods for location
x

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Frequency Decomposition
SCs are enormous x It is hard to make all decisions at once x Integration by smart decomposition x Frequency decomposition yields several sets of decisions such that each set is integrated within itself
x

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Frequency Decomposition
x

Low frequency activity, ~ once a year, high fixed cost R&D budget Capacity expansion budget Moderate frequency activity, ~ once a month
Cancellation of specific R&D projects depending on experimental outcomes

Specific machines to purchase High frequency activity, ~ once a day, low fixed cost
What experiments to start / continue today

What to produce
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Facility Location: The Cost-Response Time Frontier

An inventory location based point of view
7-Eleven Hi
Regional

Local Finished Goods (FG) Inventory

Regional FG Inventory

Cost

Local WIP (work-in-process) Central FG Inventory Central WIP

Central

Sams Club

Central Raw Material and Custom production

Low Low
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Custom production with raw material at suppliers

Pull the inventory upstream Response Time Hi

Service and Number of Facilities

Response Time

Number of Facilities
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Where inventory needs to be for a one week order response time - typical results --> 1 DC

Customer DC

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5 day order response time - typical results

--> 2 DCs

Customer DC

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3 day order response time - typical results

--> 5 DCs

Customer DC

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Next day order response time - typical

results --> 13 DCs

Customer DC

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Same day / next day order response time typical results --> 26 DCs

Customer DC

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Inbound and outbound shipping with more facilities

Supplier Manufacturer Customer

Inbound shipment

Outbound shipment

Add more facilities.

Supplier Manufacturer Distributor Retailer Customer

Inbound shipment

Outbound shipment

More inbound shipping and less outbound shipping with more facilities. Less (inbound + outbound) shipping costs with more facilities, 12 utdallas.edu/~metin if economies of scale in transportation.

Costs and Number of Facilities

Total SC Inventory Facility costs Costs

Transportation Number of facilities No economies of scale in shipment size, SC covers a larger portion with each facility. With economies of scale in inbound shipping to retailers. utdallas.edu/~metin

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Cost Build-up as a function of facilities

Total Costs

Cost of Operations

Percent Service Level Within Promised Time

Facilities Inventory Transportation Labor

Number of Facilities
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Network Design Decisions

x

Facility function: Plant, DC, Warehouse: What facility performs what function
Packaging at the manufacturer or warehouse Should a rental computer return location run diagnostic tests on the returned computers or should the testing be done at major warehouses?
x

Question arising from CRU Computer Rental Case done in OPRE6302

Facility location
Starbucks opened up at UTD student apartments in 2005 but closed in 2006! Recall Japanese 7-eleven and their blanketing strategy SMUs experimentation with Plano campus: http://www.smu.edu/legacy .

Capacity allocation
SOM car park took 80 cars in 2005 and expanded in 2006 to take about 110 cars.

Supply and market allocation: Who serves whom

By location: UT Austin serves central Texas students By grade: UT Arlington serves undergraduate students

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Strategic Factors Influencing Location Decisions

Strategic Facilities
Lead facility Global Customers Regional Customers Server Offshore
<reduced tariffs> <for exports>
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<advanced technology>
Lockheed Martins JSF in Dallas

Outpost facility
<Learn local skills>
Facilities in Japan; Toyota Prius

<local-content>

Source

Suzikis Indian venture Maruti Udyog

Contributor
<customization> <development skills>
Maruti Udyog

VW plants in Mexico Serving Latin America

<low-cost>
Nike plants in Korea

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Factors Influencing Location Decisions

x x x x x x x x

Customer response time and local presence Operating costs Technological,

Availability and economies of scale (fixed operational costs)
Semiconductor manufacturing takes place only in 5-6 countries worldwide

Infrastructure, electricity, phone lines, suppliers Macroeconomic,

Tariffs, exchange rate volatility, economic volatility Economic communities: Nafta, EU, Pacific Rim, Efta

Politic, stability Logistics and facility costs Competitive

Positive externalities
Nissan in India develops car suppliers which can also supply Suziki in India. Toyota City Shopping Malls DFW Telecom corridor hosting Alcatel, Ericsson, Nortel,

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Negative externalities, see the next slide

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Negative externality: Market Splitting by Hotellings Model 0

a

a
1-a-b

b
b

Suppose customers (preferences, e.g. sugar content in coke) are uniformly distributed over [0,1] How much does firm at a get, how about firm at b? If a locates first, where should b locate? If a estimates how b will locate in response to as location,
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where should a locate?

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A Framework for Global Site Location

Competitive STRATEGY INTERNAL CONSTRAINTS Capital, growth strategy, existing network PRODUCTION TECHNOLOGIES Cost, Scale/Scope impact, support required, flexibility COMPETITIVE ENVIRONMENT GLOBAL COMPETITION

PHASE I Supply Chain Strategy

TARIFFS AND TAX INCENTIVES

PHASE II Regional Facility Configuration

REGIONAL DEMAND Size, growth, homogeneity, local specifications POLITICAL, EXCHANGE RATE AND DEMAND RISK

PHASE III Desirable Sites

PRODUCTION METHODS Skill needs, response time FACTOR COSTS Labor, materials, site specific

AVAILABLE INFRASTRUCTURE

PHASE IV Location Choices

LOGISTICS COSTS Transport, inventory, coordination

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Comparing Locations Objectively

According to McKinsey Global Institute on HBR Jun. 2006 p.91
x x

Draw up a list of possible locations Define the decision criteria

Six common criteria used by companies
1. Cost of operating 2. Availability of the skills 3. Sales potential in the adjacent markets 4. Risk of doing the business 5. Attractiveness of living environments 6. Quality of infrastructure

x x

Collect data for each location Weight the criteria

Fortisbank of Belgium, wants to enter new large markets, gives highest weight to 3. Citibank, wants a location for a captive IT center, gives the highest weight to 4.
x

Find risk data at Economist intelligence unit: www.eiu.com UN Development Program: http://hdr.undp.org/statistics/data/

x x

Rank locations according to weighted sum of their scores Assess the dynamics of the labor pool
Availability of skilled labor
Top tier universities in the cities (How many top Business schools in Dallas?).

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Analytical Models for SC Design

x

Objective functions
Private sector deals with total costs
x

minimizes the sum of the distances to the customers minimizes the distance to the furthest customer Location of emergency response units

Public sector deals with fairness and equity

x

x x x x

Demand allocation
Distance vs. Price vs. Quality: Recall Hotelling model

Demand pattern over a geography: Discrete vs. Continuous Feasibility check

Ante vs. Post

Distances
Euclidean vs. Rectilinear Triangular inequality

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Network Optimization Models

Allocating demand to production facilities x Locating facilities x Determining capacity
x Key Costs: Fixed facility cost Transportation cost Production cost Inventory cost Coordination cost
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Which plants to establish? How to configure the network?

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A transportation network Defined by data K, D and c

n supply points c11 c14 c12 m demand points D1 K1 c22 c23 c31 K3
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D2

K2

D3 D4

c32 c34

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Demand Allocation Model: Transportation Problem

Which market is served by which plant? Which supply sources are used by a plant? Given m demand points, j=1..m with demands Dj Given n supply points, i=1..n with capacity Ki Send supplies from supply points to demand points xij = Quantity shipped from plant site i to customer j Each unit of shipment from supply point i to demand point j costs cij
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Min cij xij

i =1 j =1

s.t.

x = D
i =1 m ij

x K
j =1 ij

ij

<See transportation.xls>

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A transportation network Defined by data K, D, c and f

Which supply n supply points point operates? y1=yes or no f1,K1 c22 c23 c31 y3=yes or no f3,K3 c32 c34 D4 D3 c14 c11 c12 m demand points D1 D2

y2=yes or no f2,K2

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Plant Location with Multiple Sourcing

Which market is served by which plant? Which supply sources are used by a plant? None of the plants are open, a cost of fi is paid to open plant i At most k plants will be opened yi = 1 if plant is located at site i, 0 otherwise xij = Quantity shipped from plant site i to customer j How does cost change as k increases?

Min
i =1

f y + c x
i i i =1 j =1 ij j

ij

s.t.

x = D
i =1 m ij j =1 m ij

x K y
i

y
i =1 i

y {0,1}

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Plant Location with Single Sourcing Each customer has exactly one supplier
Which market is served by which plant? Which supply sources are used by a plant? None of the plants are open, a cost of fi is paid to open plant i

Min
i =1

f y + D c x
i i i =1 j =1 j ij

ij

s.t.

x
yi = 1 if plant is located at site i, 0 otherwise xij = 1 if market j is supplied by factory i, 0 otherwise Can a plant satisfy the demand of two or more customers with this formulation?
i =1 m j =1

ij

=1
j i

Dx K y
ij

yi , xi , j {0,1}

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Case Study: Applichem Demand Allocation

To From
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Applichem Demand Allocation (1982)

Capacity 220 Mexico 37 Canada 45 Venezuela 470 Frankfurt 185 Gary
185 30 32 11 45 115 200 36 119 26

Demand Mexico Canada 30 26

Latin America 160 Europe U.S.A Japan 200 264 119

50 Sunchem

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Applichem Production Network 1982 (with duties)

Mexico Canada Venezuela Frankfurt Gary, Indiana Sunchem Annual Cost = $72,916,400
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Mexico Canada Latin America Europe U.S.A Japan

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Applichem Production Network 1982 (without duties)

Mexico Canada Venezuela Frankfurt Gary Sunchem Annual Cost = 66,328,100 Without duties, Venezuela and Canada plants are closed and Frankfurt satisfies the excess Canada, Latin America and USA demand. There is consolidation without duties. Mexico Canada Latin America Europe U.S.A Japan

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1981 Network
Mexico Canada Venezuela Frankfurt Gary Sunchem

Mexico Canada Latin America Europe U.S.A Japan Annual Cost = $79,598,500

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1981 Network (Sunchem Closed)

Mexico Canada Venezuela Frankfurt Gary Sunchem Mexico Canada Latin America Europe U.S.A Japan Annual Cost = $82,246,800
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Cash Flows From Sunchem Plant

Year 1977 1978 1979 1980 1981 1982

Optimal 60.562 68.889 75.999 79.887 79.598 72.916 ($ Million) Sunchem Closed 60.721 68.889 77.503 80.999 82.247 72.916 0.000 1.504 1.112 2.649 0.000

Difference 0.159

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Value of Adding 0.1 M Pounds Capacity (1982)

Shadow (dual) prices from LP tells you where to invest.

Location
Capacity should be evaluated as an option and priced accordingly.
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Gravity Methods for Location

Ton Mile-Center Solution
Given n delivery locations, i=1..n, ai, bi : Coordinates of delivery location i di : Distance to delivery location i Fi : Annual tonnage to delivery location i Locate a warehouse at (x,y)

di =
Min
x,y i =1 n

( x a i ) + ( y bi )
2

F i (ai x) + (bi y)
n

<See gravitylocation.xls>

ai Fi d x = i =1n i Fi d i =1 i

bi Fi d y = i =1 i n Fi d i =1 i

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Gravity Methods for Location

Change the distance

d i = ( x ai) + ( y bi)
2

Given n delivery locations, i=1..n, ai, bi : Coordinates of delivery location i di : Distance to delivery location i Fi : Annual tonnage to delivery location i Locate a warehouse at (x,y)

Min Fi (ai x) 2 + (bi y ) 2 x, y i =1

x=

a F
i =1 n i

F
i =1

y=

b F
i =1 n i

F
i =1

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Chapter 6
Network Design in an Uncertain Environment

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A tree representation of uncertainty

x x

One way to represent Uncertainty is a binomial tree Up by 1 down by -1 move with equal probability

Normal (0, T )
2

2 = (1) 2 (0.5) + (1) 2 (0.5) = 1

<Show Applet balldrop.htm>

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T steps

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Decision tree
One column of nodes for each time period Each node corresponds to a future state
What is in a state?
x

Price, demand, inflation, exchange rate, your OPRE 6366 grade

Each path corresponds to an evolution of the states into the future Transition from one node to another determined by probabilities Evaluate the cost of a path starting from period T and work backwards in time to period 0.

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Evaluating Facility Investments: AM Tires. Section 6.5 of Chopra.

Plant
Now U.S. Demand = 100,000; Mexico demand = 50,000.
Demand is not to be met always. But selling more increases profit.

1US$ = 9 pesos. Sale price $30 in US and 240 pesos in Mexico. Future

Demand goes up or down by 20 percent with probability 0.5 and Exchange rate goes up or down by 25 per cent with probability 0.5.

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AM Tires

Period 0
How many states in period 2? Consider US demand
4 or 3 states 4x4x4 or 3x3x3

Consider the rest also

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AM Tires
Four possible capacity configurations: Both dedicated Both flexible U.S. flexible, Mexico dedicated U.S. dedicated, Mexico flexible Consider the both flexible configuration For each node solve the demand allocation model. Plants U.S. Mexico
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Markets U.S. Mexico

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AM Tires in period 2: Demand Allocation for DUS = 144; DMex = 72, E = 14.06

Max

m
i = j= 1 1 ij

ij

x ij

such that

x
i= 1

Dj Ki

x
j= 1

ij

xij 0
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Source i U.S.

1.1=240/14.06-15-1 21.2=30-110/14.06-1 9.2=(240-110)/14.06

Compare this formulation to the Transportation problem. We maximize the profit now.

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AM Tires: Demand Allocation for DU = 144; DM = 72, E = 14.06; Cheap Peso

Plants U.S. Mexico
100K; $15
. $2 1 ; 2

Markets U.S. Profit =Revenue-Cost Mexico

44K 6K; $9.2

US Productions contribution=100,000*15-1,100,000=$400,000 Mex Productions contribution=44,000*21.2+6000*9.2-4,400,000/14.06=$675,055 Profit(DU = 144; DM = 72, E = 14.06; Period 2; Both flexible)=$1,075,055

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AM Tires: Demand Allocation for DU = 144; DM = 72, E = 8.44; Expensive Peso

Plants U.S. Mexico
100K; $15
$1 K; 4 6

Markets U.S. Mexico

4 6K; $15.4

US Productions contribution=100,000*15-1,100,000=$400,000 Mex Productions contribution=44,000*16+6000*15.4-4,400,000/8.44 =704000+92400-521327=$275,073 Profit(DU = 144; DM = 72, E = 8.44; Period 2; Both flexible)=$675,073

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AM Tires: Demand Allocation for DU = 144; DM = 72, E = 5.06; Very Expensive Peso
Plants U.S. Mexico
78K; $15
22K ; $3 1.4

Markets U.S. Mexico

50K; $25.7

US Productions contribution=78000*15+22000*31.4-1,100,000=$760,800 Mex Productions contribution=50000*25.7-4,400,000/5.06=$415,435 Profit(DU = 144; DM = 72, E = 8.44; Period 2; Both flexible)=$1,176,235

Cheap Peso profit=$1,075K; Expensive Peso profit=$675K; Very Expensive Peso profit=$1,176K
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Facility Decision at AM Tires

Make profit computations for the first year nodes one by one: Compute the profit for a node and add to that (0.9)(1/8)(Sum of the profits of all 8 nodes connected to the current one)

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Capacity Investment Strategies

x x

Single sourcing is risky Hedging Strategy

Risk management?
Too much capacity or too little capacity E.g. 200 leading financial services companies are examined from 19972002. Every other company struck at least once by a risky event.
x

Source: Running with Risk. The McKinsey Quarterly. No.4. 2003.

Managers unfamiliar with risk often focus on relatively simple accounting metrics as net income, earnings per share, return on investment, etc.

Match revenue and cost exposure

x

Flexible Strategy
Excess total capacity in multiple plants Flexible technologies

More will be said in aggregate planning chapter

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Summary
Frequency decomposition x Factors influencing facility decisions x A strategic framework for facility location x Gravity methods for location x Network-LP-IP optimization models x Value capacity as a real option
x

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Location Allocation Decisions

Plants 1 2 Warehouses Markets

Which plants to establish? Which warehouses to establish? How to configure the network?
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p-Median Model
Inputs: A set of feasible plant locations, indexed by j A set of markets, indexed by i Di demand of market i No capacity limitations for plants At most p plants are to be opened dij distance between market i and plant j yj = 1 if plant is located at site j, 0 otherwise xij = 1 if market i is supplied from plant site j, 0 otherwise
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Min Di d ij xij
i j

s.t.

y
j

=p

xi , j y j for all i, j

x
j ij

ij

1 for all i
j

x ,y

{0,1} for all i, j

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p-Center Model
Replace the objective function in p-Median problem with Min Max {dij xij : i is a market assigned to plant j} We are minimizing maximum distance between a market and a plant Or say minimizing maximum distance between fire stations and all the houses served by those fire stations. An example with p=3 stations and 9 houses:

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p-Covering Model
xi = 1 if demand point i is covered, 0 otherwise yj = 1 if facility j is opened, 0 otherwise Ni facilities associated with demand point i If j is in Ni, j can serve i Can you read constraint (*) in English?

Max Di xi
i

s.t.
jN i

y
j j

xi for all i (*)

y
i

=p
j

x,y
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{0,1} for all i, j

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Other Models
x

p-Choice Models
Criteria to choose the server: distance, price?

Models with multiple decision makers

Franchise model

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