Factors Influencing Distribution Network Design in the Supply Chain

At the highest level, performance of a distribution network should be evaluated along two dimensions:

1. Value provided to the customer
2. Cost of meeting customer needs

Thus, as it compares different distribution network options, a firm must evaluate the impact on customer service and cost. The customer needs that are met influence the company’s reve­nues, which, along with cost, decide the profitability of the delivery network.

Although customer value is affected by many factors, we focus on measures that are influ­enced by the structure of the distribution network:

• Response time
• Product variety
• Product availability
• Customer experience
• Time to market
• Order visibility
• Returnability

Response time is the amount of time it takes for a customer to receive an order. Product variety is the number of different products or configurations that are offered by the distribution network. Prod­uct availability is the probability of having a product in stock when a customer order arrives. Customer experience includes the ease with which customers can place and receive orders and the extent to which this experience is customized. It also includes purely experiential aspects, such as the possibility of getting a cup of coffee and the value that the sales staff provides. Time to market is the time it takes to bring a new product to the market. Order visibility is the ability of customers to track their orders from placement to delivery. Returnability is the ease with which a customer can return unsatisfactory merchandise and the ability of the network to handle such returns.

It may seem, at first, that a customer always wants the highest level of performance along all these dimensions. In practice, however, this is not the case. Customers ordering a book at Amazon are willing to wait longer than those who drive to a nearby Barnes & Noble store to get the same book. In contrast, customers can find a much larger variety of books at Amazon com­pared with the selection at the Barnes & Noble store. Thus, Amazon customers trade off fast response times for high levels of variety.

Firms that target customers who can tolerate a long response time require only a few loca­tions that may be far from the customer. These companies can focus on increasing the capacity of each location. In contrast, firms that target customers who value short response times need to locate facilities close to them. These firms must have many facilities, each with a low capacity. Thus, a decrease in the desired response time increases the number of facilities required in the network, as shown in Figure 4-1. For example, Barnes & Noble provides its customers with books on the same day but requires hundreds of stores to achieve this goal for most of the United States. Amazon, in contrast, takes a few days to deliver a book to its U.S. customers, but it uses only about forty locations to store its books.

Changing the distribution network design affects the following supply chain costs (notice that these are four of the six supply chain drivers we discussed earlier):

• Inventories
• Transportation
• Facilities and handling
• Information

The other two drivers, sourcing and pricing, also affect the choice of the distribution sys­tem; these links will be discussed when relevant.

As the number of facilities in a supply chain increases, the required inventory increases (see Chapter 12), as shown in Figure 4-2. To decrease inventory costs, firms try to consolidate and limit the number of facilities in their supply chain network. For example, Amazon is able to turn its inventory about twice as frequently as Barnes & Noble because it has far fewer facilities.

Inbound transportation costs are the costs incurred in bringing material into a facility. Outbound transportation costs are the costs of sending material out of a facility. Outbound trans­portation costs per unit tend to be higher than inbound costs because inbound lot sizes are typi­cally larger. For example, an Amazon warehouse receives full truckload shipments of books on the inbound side, but ships out small packages with only a few books per customer on the out­bound side. Increasing the number of warehouse locations decreases the average outbound dis­tance to the customer and makes outbound transportation distance a smaller fraction of the total distance traveled by the product. Thus, as long as inbound transportation economies of scale are maintained, increasing the number of facilities decreases total transportation cost, as shown in Figure 4-3. If the number of facilities is increased to a point at which inbound lot sizes are also very small and result in a significant loss of economies of scale in inbound transportation, increasing the number of facilities increases total transportation cost, as shown in Figure 4-3.

Facility costs decrease as the number of facilities is reduced, as shown in Figure 4-4, because a consolidation of facilities allows a firm to exploit economies of scale.

Total logistics costs are the sum of inventory, transportation, and facility costs for a supply chain network. As the number of facilities increases, total logistics costs first decrease and then increase, as shown in Figure 4-5. Each firm should have at least the number of facilities that minimizes total logistics costs. Amazon has more than one warehouse primarily to reduce its logistics costs (and improve response time). If a firm wants to reduce the response time to its customers further, 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 will be greater than the increase in costs because of the additional facilities.

The customer service and cost components listed earlier are the primary measures used to evaluate different delivery network designs. In general, no distribution network will outperform others along all dimensions. Thus, it is important to ensure that the strengths of the distribution network fit with the strategic position of the firm.

In the next section, we discuss various distribution networks and their relative strengths and weaknesses.

Source: Chopra Sunil, Meindl Peter (2014), Supply Chain Management: Strategy, Planning, and Operation, Pearson; 6th edition.