SC Design

Facility Location
Sections 4.1, 4.2
Chapter 5 and 6

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

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

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 Frequency Decomposition
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 Regional
Hi
Local Finished Goods (FG) Inventory

Regional FG Inventory

Cost Local WIP (work-in-process) Central

Central FG Inventory Sams Club
Central WIP
Central Raw Material and Custom production

Custom production with raw material at suppliers

Low
Pull the inventory upstream
Low Response Time Hi
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 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,
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 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.
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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
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?
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
<advanced technology>
Global Customers Regional Customers Lockheed Martins JSF in Dallas

Server Outpost facility

<local-content> <Learn local skills>
Offshore Suzikis Indian venture
Facilities in Japan; Toyota Prius

<reduced tariffs> Maruti Udyog

Contributor
<for exports> Source <customization>
VW plants in Mexico <low-cost> <development skills>
Serving Latin America Nike plants in Korea
Maruti Udyog 16
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 Factors Influencing Location Decisions
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 17
 Negative externality:
Market Splitting by Hotellings Model

0 a b 1
1-a-b
a 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,

where should a locate? 18
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 A Framework for Global Site Location
Competitive STRATEGY GLOBAL COMPETITION
PHASE I
Supply Chain
INTERNAL CONSTRAINTS Strategy TARIFFS AND TAX
Capital, growth strategy, INCENTIVES
existing network

PRODUCTION TECHNOLOGIES REGIONAL DEMAND

Cost, Scale/Scope impact, support PHASE II Size, growth, homogeneity,
required, flexibility
Regional Facility local specifications
Configuration
COMPETITIVE
ENVIRONMENT POLITICAL, EXCHANGE
RATE AND DEMAND RISK

PHASE III
Desirable Sites AVAILABLE
INFRASTRUCTURE
PRODUCTION METHODS
Skill needs, response time

FACTOR COSTS PHASE IV LOGISTICS COSTS

Labor, materials, site specific Location Choices Transport, inventory, coordination

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 Comparing Locations Objectively
According to McKinsey Global Institute on HBR Jun. 2006 p.91

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
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.
Find risk data at
Economist intelligence unit: www.eiu.com
UN Development Program: http://hdr.undp.org/statistics/data/
Rank locations according to weighted sum of their scores
Assess the dynamics of the labor pool
Availability of skilled labor
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Top tier universities in the cities (How many top Business schools in Dallas?). 20
 Analytical Models for SC Design
Objective functions
Private sector deals with total costs
minimizes the sum of the distances to the customers
Public sector deals with fairness and equity
minimizes the distance to the furthest customer
Location of emergency response units
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
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Triangular inequality 21
 Network Optimization Models
Allocating demand to production facilities
Locating facilities
Determining capacity

Key Costs:

Fixed facility cost

Transportation cost
Production cost
Inventory cost
Coordination cost

Which plants to establish? How to configure the network? 22

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 A transportation network
Defined by data K, D and c
n supply points m demand points
D1
c11
K1 D2
c12
c14
K2 c22
c23
c31 D3

K3 c32
c34 D4

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Demand Allocation Model: Transportation Problem
Which market is served by which plant? n m
Which supply sources are used by a plant? Min cij xij
i 1 j 1

Given m demand points, j=1..m s.t.

with demands Dj n

Given n supply points, i=1..n x D

i 1
ij j
with capacity Ki
m

Send supplies from supply points to demand points

x K
j 1
ij i

xij = Quantity shipped from plant site i to customer j

x ij
0
Each unit of shipment from supply point i to demand
point j costs cij
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<See transportation.xls> 24
 A transportation network
Defined by data K, D, c and f
Which supply n supply points m demand points
point operates?
D1
c11
y1=yes or no f1,K1 D2
c12
c14
y2=yes or no f2,K2 c22
c23
c31 D3
y3=yes or no f3,K3 c32
c34 D4

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 Plant Location with Multiple Sourcing
n n m
Which market is served by which plant?
Min f y c x
Which supply sources are used by a plant? i i ij ij
i 1 i 1 j 1

s.t.
None of the plants are open, a cost of f i is
n
paid to open plant i
x D
i 1
ij j

At most k plants will be opened m

x K y
j 1
ij i i
yi = 1 if plant is located at site i, 0
m
otherwise
xij = Quantity shipped from plant site i to y
i 1
i
k
customer j
y {0,1}
i
How does cost change as k increases? 26
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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?
n n m
Min f y D c x j
None of the plants are open, a cost of f i is i 1
i i
i 1 j 1
ij ij

paid to open plant i

s.t.
n

x
i 1
ij
1

yi = 1 if plant is located at site i, m

0 otherwise Dx K y
j 1
j ij i i
xij = 1 if market j is supplied by factory i,
yi , xi , j {0,1}
0 otherwise

Can a plant satisfy the demand of two or

more customers with this formulation? 27
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 Case Study: Applichem Demand Allocation

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 Applichem Demand Allocation (1982)
Demand
Capacity
30 Mexico 30
220 Mexico
32
26 Canada 2
37 Canada
11
45 Venezuela 45 Latin America 160
115
470 Frankfurt 200 Europe 200
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185 185 U.S.A 264
Gary
119
50 Sunchem Japan 119

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 Applichem Production Network 1982
(with duties)

Mexico Mexico

Canada Canada

Venezuela Latin America

Frankfurt Europe
Gary, Indiana U.S.A
Sunchem Japan

Annual Cost = $72,916,400

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 Applichem Production Network 1982
(without duties)
Mexico Mexico
Canada Canada
Venezuela Latin America
Frankfurt Europe
Gary U.S.A
Sunchem Japan
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. 31
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 1981 Network

. Mexico
Mexico
Canada Canada

Venezuela Latin America

Frankfurt Europe
Gary U.S.A
Sunchem Japan

Annual Cost = $79,598,500

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 1981 Network (Sunchem Closed)

Mexico Mexico

Canada Canada

Venezuela Latin America

Frankfurt Europe
Gary U.S.A
Sunchem Japan

Annual Cost = $82,246,800

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Value of Adding 0.1 M Pounds Capacity (1982)

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

Capacity should be evaluated as an option and priced accordingly.

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 Gravity Methods for Location

Ton Mile-Center Solution di ( x ai) ( y bi)

2 2

Given n delivery locations, i=1..n,

ai, bi : Coordinates of delivery location i n
Min 2 2
di : Distance to delivery location i
Fi : Annual tonnage to delivery location i
x, y
i 1
F i (ai x) (bi y)
n n
Locate a warehouse at (x,y) ai Fi bi Fi

i 1 d i

i 1 d i
x n y n
Fi Fi
<See gravitylocation.xls> i 1 d i
i 1 d i

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 Chapter 6
Network Design in an Uncertain Environment

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 A tree representation of uncertainty
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 39
 Decision tree
One column of nodes for each time period
Each node corresponds to a future state
What is in a state?
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.

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

How many states

in period 2?
Consider US demand
4 or 3 states
Consider the rest also
4x4x4 or 3x3x3

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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 Markets
U.S. U.S.

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

1.1=240/14.06-15-1
2 2
21.2=30-110/14.06-1
Max m ij x ij 9.2=(240-110)/14.06
i 1 j1

such that
2

x ij Dj Compare this formulation to the Transportation problem.

i 1 We maximize the profit now.
2

x
j 1
ij Ki

xij 0
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 AM Tires: Demand Allocation for DU = 144;
DM = 72, E = 14.06; Cheap Peso
Plants Markets
100K; $15
U.S. U.S.
2 1. 2 Profit =Revenue-Cost
; $
44 K
Mexico Mexico
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 Markets
100K; $15
U.S. U.S.
$1 6
4 K ;
4
Mexico Mexico
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 Markets
78K; $15
U.S. U.S.
22K
; $3
1.4
Mexico 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 47
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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
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 1997-
2002. Every other company struck at least once by a risky event.
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
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
Factors influencing facility decisions
A strategic framework for facility location
Gravity methods for location
Network-LP-IP optimization models
Value capacity as a real option

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 Location Allocation Decisions
Plants Warehouses Markets
1

Which plants to establish? Which warehouses to establish?

How to configure the network?
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 p-Median Model
Inputs: Min Di d ij xij
A set of feasible plant locations, indexed by j i j
A set of markets, indexed by i s.t.

y
Di demand of market i
No capacity limitations for plants
p
j
j
At most p plants are to be opened
xi , j y j for all i, j
dij distance between market i and plant j

yj = 1 if plant is located at site j,

x
j
ij
1 for all i
0 otherwise
xij = 1 if market i is supplied from plant site j, x ,y ij j
{0,1} for all i, j
0 otherwise

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 p-Center Model
Replace the objective function in p-Median problem with
Min Max {dijxij : 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 Max Di xi
otherwise i
yj = 1 if facility j is opened, 0 otherwise
s.t.
Ni facilities associated with demand point

y
i
xi for all i (*)
If j is in Ni, j can serve i j
jN i

Can you read constraint (*) in English? y

j
j p

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

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 Other Models
p-Choice Models
Criteria to choose the server: distance, price?
Models with multiple decision makers
Franchise model

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