This paper describes a framework for designing the distribution network in a supply chain, Exams of Network Theory

Download This paper describes a framework for designing the distribution network in a supply chain and more Exams Network Theory in PDF only on Docsity! 1 Designing the Distribution Network in a Supply Chain Sunil Chopra Kellogg School of Management, Northwestern University 2001 Sheridan Road, Evanston, IL 60208, U.S.A Tel: 1-847-491-8169; Fax: 1-847-467-1220; e-mail:s-chopra@kellogg.northwestern.edu Abstract This paper describes a framework for designing the distribution network in a supply chain. Various factors influencing the choice of distribution network are described. We then discuss different choices of distribution networks and their relative strengths and weaknesses. The paper concludes by identifying distribution networks that are best suited for a variety of customer and product characteristics. 0. Introduction Distribution refers to the steps taken to move and store a product from the supplier stage to a customer stage in the supply chain. Distribution is a key driver of the overall profitability of a firm because it directly impacts both the supply chain cost and the customer experience. Good distribution can be used to achieve a variety of supply chain objectives ranging from low cost to high responsiveness. As a result, companies in the same industry often select very different distribution networks. Dell distributes its PCs directly to end consumers, while companies like Hewlett Packard and Compaq distribute through resellers [3]. Dell customers wait several days to get a PC while customers can walk away with an HP or Compaq PC from a reseller. Gateway opened Gateway Country stores where customers could check out the products and have sales people help them configure a PC that suited their needs. Gateway, however, chose to sell no products at the stores, with all PCs shipped directly 2 from the factory to the customer. In 2001, Gateway closed several of these stores given their poor financial performance. Apple Computers is planning to open retail stores where computers will be sold [4]. These PC companies have chosen three different distribution models. How can we evaluate this wide range of distribution choices? Which ones serve the companies and their customers better? W.W. Grainger, an MRO distributor, stocks about 100,000 skus that can be sent to customers within a day of the order being placed. The remaining slower moving products are not stocked but shipped directly from the manufacturer when a customer places an order. It takes several days for the customer to receive the product in this case. Are these distribution choices appropriate? How can they be justified? When should a distribution network include an additional stage such as a distributor? Proponents of e-business had predicted the death of intermediaries like distributors. Why were they proved wrong in many industries? In this paper we provide a framework and identify key dimensions along which to evaluate the performance of any distribution network. 1. Factors Influencing Distribution Network Design At the highest level, performance of a distribution network should be evaluated along two dimensions: 1. Customer needs that are met 2. Cost of meeting customer needs The customer needs that are met influence the company's revenues, which along with cost decide the profitability of the delivery network. 5 network with more than one warehouse allows Amazon.com to reduce transportation cost relative to a network with a single warehouse. Facility costs decrease as the number of facilities is reduced as shown in Figure 4.2, because a consolidation of facilities allows a firm to exploit economies of scale. --------------------------------------------- Insert Figure 4.2 Here ---------------------------------------------- Total logistics costs are the sum of inventory, transportation, and facility costs for a supply chain network. As the number of facilities is increased, total logistics costs first decrease and then increase as shown in Figure 4.3. Each firm should have at least the number of facilities that minimize total logistics costs. As a firm wants to further reduce the response time to its customers, it may have to increase the number of facilities beyond the point that minimizes logistics costs. A firm should add facilities beyond the cost- minimizing point only if managers are confident that the increase in revenues because of better responsiveness is greater than the increase in costs because of the additional facilities. --------------------------------------------- Insert Figure 4.3 Here ---------------------------------------------- 2. Design Options for a Distribution Network We will discuss distribution network choices in the context of distribution from the manufacturer to the end consumer. When considering distribution between any other pair of stages, such as supplier to 6 manufacturer, many of the same options still apply. There are two key decisions when designing a distribution network: 1. Will product be delivered to the customer location or picked up from a preordained site? 2. Will product flow through an intermediary (or intermediate location)? Based on the choices for the two decisions, there are six distinct distribution network designs that are classified as follows: 1. Manufacturer storage with direct shipping 2. Manufacturer storage with direct shipping and in-transit merge 3. Distributor storage with package carrier delivery 4. Distributor storage with last mile delivery 5. Manufacturer / distributor storage with costumer pickup 6. Retail storage with customer pickup We now describe each distribution option and discuss its strengths and weaknesses. 2.1 Manufacturer Storage with Direct Shipping In this option, product is shipped directly from the manufacturer to the end customer, bypassing the retailer (who takes the order and initiates the delivery request). This option is also referred to as drop shipping. All inventories are stored at the manufacturer. Information flows from the customer, via the retailer, to the manufacturer, while product is shipped directly from the manufacturer to customers as shown in Figure 4.4. In some instances like Dell, the manufacturer sells directly to the customer. Online retailers such as eBags and Nordstrom.com use drop shipping to deliver goods to the end consumer. eBags does not hold any inventory of bags and has them drop shipped directly from the manufacturer to the customer. Nordstrom carries some products in inventory while using the drop-ship 7 model for slow moving footwear. W.W. Grainger also uses drop shipping to deliver slow moving items that are not carried in inventory. --------------------------------------------- Insert Figure 4.4 Here ---------------------------------------------- The biggest advantage of drop shipping is the ability to centralize inventories at the manufacturer. A manufacturer can aggregate demand and provide a high level of product availability with lower levels of inventory than individual retailers. The benefits from centralization are highest for high value, low volume items with unpredictable demand. The decision of Nordstrom to drop-ship low volume shoes satisfies these criteria. Similarly, bags sold by eBags tend to have high value and low relatively volume per sku. The inventory benefits of aggregation are small for items with predictable demand and low value [1]. Thus, drop shipping would not offer a significant inventory advantage to an online grocer selling a staple item like detergent. Drop shipping also offers the manufacturer the opportunity to further lower inventories by postponing customization until after the customer order has been placed. Build-to-order companies such as Dell hold inventories as common components and postpone product customization, thus lowering the level of inventories carried. Transportation costs are high with drop shipping because the average outbound distance to the end consumer is large and package carriers must be used to ship the product. Package carriers have high shipping costs per unit compared to truckload(TL) or less-than-truckload (LTL) carriers. With drop shipping, a customer order with items from several manufacturers will involve multiple shipments to the customer. This loss in aggregation in outbound transportation further increases cost. 10 --------------------------------------------- Insert Table 4.1 Here ---------------------------------------------- Given its performance characteristics, manufacturer storage with direct shipping is best suited for a large variety of low demand, high value items where customers are willing to wait for delivery and accept several partial shipments. Manufacturer storage is also suitable if it allows the manufacturer to postpone customization, thus reducing inventories. For drop-shipping to be effective, there should be few sourcing locations per order. It is thus ideal for direct sellers that are able to build-to-order. Drop shipping is hard to implement if there are more than 20-30 sourcing locations that have to ship directly to customers on a regular basis. For products with very low demand, however, drop shipping may be the only option. 2.2 Manufacturer Storage With Direct Shipping and In-Transit Merge Unlike pure drop shipping where each product in the order is sent directly from each manufacturer to the end customer, in-transit merge combines pieces of the order coming from different locations so that the customer gets a single delivery. Information and product flows for the in-transit merge network are as shown in Figure 4.5. When a customer orders a PC from Dell along with a Sony monitor, the package carrier picks up the PC at the Dell factory, the monitor at the Sony factory and merges the two together at a hub before making a single delivery to the customer. --------------------------------------------- Insert Figure 4.5 Here ---------------------------------------------- 11 As with drop shipping, the ability to aggregate inventories and postpone product customization is a significant advantage of in-transit merge. In-transit merge allows Dell and Sony to aggregate all their inventories at the factory. This approach will have the greatest benefits for products with high value whose demand is hard to forecast, in particular if product customization can be postponed. In most cases, transportation costs are lower than drop shipping because of the merge that takes place at the carrier hub prior to delivery to the customer. An order with products from three manufacturers thus requires only one delivery to the customer compared to three that would be required with drop shipping. Fewer deliveries save transportation cost and simplify receiving. Facility and processing costs for the manufacturer and the retailer are as in drop shipping. The party performing the in-transit merge has higher facility costs because of the merge capability required. Receiving costs at the customer are lower because a single delivery is received. Overall supply chain facility and handling costs are somewhat higher than drop shipping. A very sophisticated information infrastructure is needed to allow the in-transit merge. Besides information, operations at the retailer, manufacturers, and the carrier must be coordinated. The investment in information infrastructure will be higher than for drop shipping. Response times, product variety, and availability are similar to drop shipping. Response times may be marginally higher because of the need to perform the merge. Customer experience is likely to be better than drop shipping because the customer receives only one delivery for their order instead of many partial shipments. Order visibility is a very important requirement. While the initial setup is difficult because it requires integration of manufacturer, carrier, and retailer, tracking itself becomes easier given the merge that occurs at the carrier hub. Up to the point of merge, the order from each 12 manufacturer is tracked separately. After that the order can be tracked as a single unit. Returnability is similar to drop shipping. Problems in handling returns are very likely and the reverse supply chain will continue to be expensive and difficult to implement as with drop shipping. The performance of factory storage with in-transit merge is compared with drop shipping in Table 4.2. --------------------------------------------- Insert Table 4.2 Here ---------------------------------------------- The main advantage of in-transit merge over drop shipping is the somewhat lower transportation cost and improved customer experience. The major disadvantage is the additional effort during the merge itself. Given its performance characteristics, manufacturer storage with in-transit merge is best suited for low to medium demand, high value items where the retailer is sourcing from a limited number of manufacturers. Compared to drop shipping, in-transit merge requires a higher volume from each manufacturer to be effective. If there are too many sources, in-transit merge can be very difficult to coordinate and implement. In-transit merge is best implemented if there are no more than four or five sourcing locations and each customer order has products from multiple locations. The in-transit merge of a Dell PC with a Sony monitor is appropriate because product variety is high but there are few sourcing locations with relatively large total volume from each sourcing location. 2.3 Distributor Storage with Carrier Delivery Under this option, inventory is not held by manufacturers at the factories but is held by distributors / retailers in intermediate warehouses and package carriers are used to transport products from the 15 customer order. Returnability is better than with manufacturer storage because all returns can be processed at the warehouse itself. The customer also has to return only one package even if the items are from several manufacturers. The performance of distributor storage with carrier delivery is summarized in Table 4.3. --------------------------------------------- Insert Table 4.3 Here ---------------------------------------------- Distributor storage with carrier delivery is well suited for medium to fast moving items. Distributor storage also makes sense when customers want delivery faster than offered by manufacturer storage but do not need it immediately. Distributor storage can handle somewhat lower variety than manufacturer storage but can handle a much higher level of variety than a chain of retail stores. 2.4 Distributor Storage with Last Mile Delivery Last mile delivery refers to the distributor / retailer delivering the product to the customer's home instead of using a package carrier. Webvan, Peapod, and Alberston's have used last mile delivery in the grocery industry. Unlike package carrier delivery, last mile delivery requires the distributor warehouse to be much closer to the customer, increasing the number of warehouses required. The warehouse storage with last mile delivery network is as shown in Figure 4.7. --------------------------------------------- Insert Figure 4.7 Here ---------------------------------------------- 16 Distributor storage with last mile delivery requires higher levels of inventory than all options other than retail stores, because it has a lower level of aggregation. From an inventory perspective, warehouse storage with last mile delivery is suitable for relatively fast moving items where disaggregation does not lead to a significant increase of inventory. Staple items in the grocery industry fit this description. Transportation costs are highest using last mile delivery. This is because package carriers aggregate delivery across many retailers and are able to obtain better economies of scale than available to a distributor / retailer attempting last mile delivery. Delivery costs (including picking and transportation) can be as high as $30-$40 per home delivery in the grocery industry. Last mile delivery may be somewhat cheaper in dense cities. Transportation costs may also be justifiable for bulky products where the customer is willing to pay for home delivery. Home delivery for water and large bags of rice has proved quite successful in China, where the high population density has helped decrease delivery costs. Facility and processing costs are very high using this option given the large number of facilities required. Facility costs are somewhat lower than a network with retail stores but much higher than either manufacturer storage or distributor storage with package carrier delivery. Processing costs, however, are much higher than a network of retail stores because all customer participation is eliminated. A grocery store doing last mile delivery, performs all the processing until the product is delivered to the customer's home unlike a supermarket where there is much more customer participation. The information infrastructure with last mile delivery is similar to distributor storage with package carrier delivery. It requires, however, the additional capability of scheduling deliveries. 17 Response times are faster than the use of package carriers. Product variety is generally lower than distributor storage with carrier delivery. The cost of providing product availability is higher than every option other than retail stores. The customer experience is very good using this option, particularly for bulky, hard to carry items. Order visibility is less of an issue given that deliveries are made within 24 hours. The order-tracking feature does become important to handle exceptions in case of incomplete or undelivered orders. Of all the options discussed, returnability is best with last mile delivery because trucks making deliveries can also pick up returns from customers. Returns are more expensive to handle than at a retail store where a customer can bring the product back. The performance characteristics of distributor storage with last mile delivery are summarized in Table 4.4. --------------------------------------------- Insert Table 4.4 Here ---------------------------------------------- In areas with high labor cost, it is very hard to justify distributor storage with last mile delivery on the basis of efficiency or improved margin. It can only be justified if there is a large enough customer segment willing to pay for this convenience. In that case, an effort should be made to couple last mile delivery with an existing network to exploit economies of scale and improve utilization. An example is Albertson's use of existing grocery store facilities and labor to provide home delivery. A portion of the grocery store serves as a fulfillment center for online orders as well as a replenishment center for the grocery store itself. This helps improve utilization and lower the cost of providing this service. Last mile delivery may be justifiable if customer orders are large enough and customers are willing to pay 20 and pick up their orders. On the other hand, customers who do not want to pay online can pay by cash using this option. In countries like Japan where 7 Eleven has over 8,000 outlets, it can be argued that the loss of customer convenience is small because most customers are close to a pickup site and can collect their order at their own convenience. In some cases, this option can be considered more convenient because it does not require the customer to be at home at the time of delivery. Order visibility is extremely important for customer pickups. The customer must be informed when the order has arrived and the order should be easily identified once the customer arrives to pick it up. Such a system will be hard to implement because it requires integration of several stages in the supply chain. Returns can potentially be handled at the pickup site. The problem with some existing sites such as 7 Eleven stores is that they are not equipped to accept and process returns for products not sold at the stores. From a transportation perspective, however, return flows can be handled using the delivery trucks. For customers, returning a product will be easy because they have a physical location to bring it to. Overall, returnability is fairly good using this option. The performance characteristics of manufacturer or distributor storage with consumer pickup sites are summarized in Table 4.5. --------------------------------------------- Insert Table 4.5 Here ---------------------------------------------- The main advantage of a network with consumer pickup sites is that it can lower delivery cost, thus expanding the set of products sold as well as customers served online. The major hurdle is the increased handling cost at the pickup site. Such a network is likely to be most effective if existing locations such as convenience or grocery stores are used as pickup sites because such a network 21 improves the economies from existing infrastructure. Unfortunately, such sites are typically designed to allow the customer to do the picking and will need to develop the capability of picking a customer specific order. 2.6 Retail Storage with Customer Pickup In this option, inventory is stored locally at retail stores. Customers either walk into the retail store or place an order online or on the phone, and pick it up at the retail store. Examples of companies that offer multiple options of order placement include Albertsons.com. Albertsons uses part of the facility as a grocery store and part of the facility as an online fulfillment center. Customers can walk into the store or order online. A B2B example is W. W. Grainger where customers can order online, by phone, or in person and pick up their order at one of the Grainger retail outlets. Alberston's stores its inventory at the pickup location itself. In the case of Grainger, some items are stored at the pickup location while others may come from a central location. Local storage increases inventory costs because of lack of aggregation. For very fast moving items, however, there is marginal increase in inventory even with local storage. Albertson's uses local storage given that most of its products are relatively fast moving and are being stocked at the supermarket in any case. Similarly, Grainger keeps its inventory of fast moving items at pickup locations, while slow moving items are stocked at a central warehouse. Transportation cost is much lower than other solutions because inexpensive modes of transport can be used to replenish product at the retail store. Facility costs are high because many local facilities are required. A minimal information infrastructure is needed if customers walk into the store and place 22 their order. For online orders, however, a significant information infrastructure is needed to provide visibility of the order until the customer picks it up. Very good response times can be achieved in this case because of local storage. For example, both Alberston's and Grainger offer same day pickup from their retail locations. Product variety stored locally will be lower than other options. It is more expensive than all other options to provide a high level of product availability. Order visibility is extremely important for customer pickups where orders are placed online or on the phone. Returns can be handled at the pickup site. Overall, returnability is fairly good using this option. The performance characteristics of a network with customer pickup sites and local storage (such as retail stores) are summarized in Table 4.6. --------------------------------------------- Insert Table 4.6 Here ---------------------------------------------- The main advantage of a network with local storage is that it can lower the delivery cost and provide a faster response than other networks. The major disadvantage is the increased inventory and facility costs. Such a network is best suited for fast moving items or items where customers value the rapid response. 25 Finally, intermediaries such as distributors add value to a supply chain between a supply stage and a customer stage if there are many small players at the customer stage, each requiring a small amount of the product at a time. The value added increases if distributors carry products from many manufacturers. Improvement in supply chain performance occurs for the following reasons: • Reduction in inbound transportation cost because of truckload shipments from manufacturers to distributor • Reduction in outbound transportation cost because the distributor combines products from many manufacturers into a single outbound shipment • Reduction in inventory costs because distributor aggregates safety inventory rather than disaggregating at each retailer • A more stable order stream from distributor to manufacturer (compared to erratic orders from each retailer) allows manufacturers to lower cost by planning production more effectively • By carrying inventory closer to the point of sale, distributors are able to provide a better response time than manufacturers can • Distributors are able to offer one stop shopping with products from several manufacturers References 1. Chopra, Sunil and Peter Meindl. Supply Chain Management: Strategy, Planning, Operation. Prentice Hall, New Jersey, 2001. 2. Fulford, Benjamin. "I got it @ 7-Eleven." Forbes, April 03, 2000. 3. Magretta, Joan. "The Power of Virtual Integration: An Interview with Dell Computer's Michael Dell." Harvard Business Review (March-April 1998), 72-84. 26 4. Wong, Nicole C. "Apple's Time to Grow: Computer Maker Expanding in Downturn." The Washington Post, December 04, 2001. 27 Desired Response Time Required Number of Facilities Figure 4.1: Relationship between desired response time and number of facilities 30 Manufacturer Customers Retailer Product Flow Information Flow Figure 4.4: Manufacturer Storage with Direct Shipping 31 In transit merge by Carrier Factories Customers Retailer Product Flow Information Flow Figure 4.5: In-Transit Merge Network 32 Warehouse Storage by Distributor / Retailer Factories Customers Product Flow Information Flow Figure 4.6: Distributor Storage with Carrier Delivery 35 Cost Factor Performance Inventory Lower costs because of aggregation. Benefits of aggregation are highest for low volume, high value items. Benefits are very large if product customization can be postponed at the manufacturer Transportation Higher transportation costs because of increased distance and disaggregate shipping Facilities and handling Lower facility costs because of aggregation. Some saving on handling costs if manufacturer can manage small shipments or ship from production line Information Significant investment in information infrastructure to integrate manufacturer and retailer Service Factor Performance Response time High response time of between 1-2 weeks because of increased distance and two stages for order processing. Response time may vary by product, thus complicating receiving Product variety Easy to provide a very high level of variety Product availability Easy to provide a high level of product availability because of aggregation at manufacturer Customer experience Good in terms of home delivery but can suffer if order from several manufacturers is sent as partial shipments Order visibility More difficult but also more important from a customer service perspective Returnability Expensive and difficult to implement Table 4.1: Performance Characteristics of Manufacturer Storage with Direct Shipping Network 36 Cost Factor Performance Inventory Similar to drop shipping Transportation Somewhat lower transportation costs than drop-shipping Facilities and handling Handling costs higher than drop shipping at carrier, receiving costs lower at customer Information Investment is somewhat higher than for drop-shipping Service Factor Performance Response time Similar to drop shipping, may be marginally higher Product variety Similar to drop shipping Product availability Similar to drop shipping Customer experience Better than drop shipping because a single delivery has to be received Order visibility Similar to drop shipping Returnability Similar to drop shipping Table 4.2: Performance characteristics of in-transit merge 37 Cost Factor Performance Inventory Higher than manufacturer storage. Difference is not large for faster moving items Transportation Lower than manufacturer storage. Reduction is highest for faster moving items Facilities and handling Somewhat higher than manufacturer storage. The difference can be large for slow moving items Information Simpler infrastructure compared to manufacturer storage Service Factor Performance Response time Faster than manufacturer storage Product variety Lower than manufacturer storage Product availability Higher cost to provide the same level of availability as manufacturer storage Customer experience Better than manufacturer storage with drop shipping Order visibility Easier than manufacturer storage Returnability Easier than manufacturer storage Table 4.3: Performance Characteristics of Distributor Storage with Carrier Delivery 40 Cost Factor Performance Inventory Higher than all other options Transportation Lower than all other options Facilities and handling Higher than other options. The increase in handling cost at the pickup site can be significant for online and phone orders Information Some investment in infrastructure required for online and phone orders Service Factor Performance Response time Same day (immediate) pickup possible for items stored locally at pickup site Product variety Lower than all other options Product availability More expensive to provide than all other options Customer experience Related to whether shopping is viewed as a positive or negative experience by customer Order visibility Trivial for in store orders. Difficult, but essential, for online and phone orders Returnability Easier than other options given that pickup location can handle returns Table 4.6: Performance Characteristics of local storage at consumer pickup sites 41 Retail Storage with Customer Pickup Manufacturer Storage with Direct Shipping Manufacturer Storage with In-Transit Merge Distributor Storage with Package Carrier Delivery Distributor storage with last mile delivery Manufacturer storage with pickup Response Time 1 4 4 3 2 4 Product Variety 4 1 1 2 3 1 Product Availability 4 1 1 2 3 1 Customer Experience 5 4 3 2 1 5 Order Visibility 1 5 4 3 2 6 Returnability 1 5 5 4 3 2 Inventory 4 1 1 2 3 1 Transportation 1 4 3 2 5 1 Facility & Handling 6 1 2 3 4 5 Information 1 4 4 3 2 5 Table 4.7: Comparative Performance of Delivery Network Designs 42 ++: Very suitable; +: Somewhat suitable; +-: Neutral; -: Somewhat unsuitable; --: Very unsuitable. Retail Storage with Customer Pickup Manufacturer Storage with Direct Shipping Manufacturer Storage with In-Transit Merge Distributor Storage with Package Carrier Delivery Distributor storage with last mile delivery Manufacturer storage with pickup High demand product ++ -- - +- + - Medium demand product + - +- + +- +- Low demand product - + +- + - + Very low demand product -- ++ + +- -- + Many product sources + - - ++ + +- High product value - ++ + + +- ++ Quick desired response ++ -- -- - + -- High product variety - ++ +- + +- ++ Low customer effort -- + ++ ++ ++ - Table 4.8: Performance of Delivery Networks for Different Product/Customer Characteristics