Supply Network Design Lecture 5
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An organization should take a total supply network perspective for three key reasons: 1) It helps understand competitiveness by looking beyond immediate customers and suppliers to understand how they are influenced. 2) It helps identify significant links in the network that contribute most to end customer objectives. 3) It helps focus on long-term issues and whether to assist or replace weak links in the network. When designing a supply network, the most strategic decisions are how to configure the network through outsourcing and vertical integration, and where to locate each part of the network considering factors like proximity to materials, markets, labor costs and future expansion plans. Methods for evaluating location options include weighted scoring of criteria and the center of gravity method
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Supply Network Design Lecture 5
- 2. Supply network design • Introduction • Key questions: ➤ Why should an organization take a total supply network perspective? ➤ What is involved in configuring a supply network? ➤ Where should an operation be located?
- 3. Introduction • No operation exists in isolation. Every operation is part of a larger and interconnected network of other operations. This supply network includes suppliers and customers. It also includes suppliers’ suppliers and customers’ customers, and so on. At a strategic level, operations managers are involved in ‘designing’ the shape and form of their network. Network design starts with setting the network’s strategic objectives. This helps the operation to decide how it wants to influence the overall shape of its network, the location of each operation, and how it should manage its overall capacity within the network.
- 4. Why should an organization take a total supply network perspective? • The supply network perspective – Supply network – Supply side – Demand side – First-tier – Second-tier – Immediate supply network – Total supply network
- 6. The supply network perspective Supply network: A supply network perspective means setting an operation in the context of all the other operations with which it interacts, some of which are its suppliers and its customers. Materials, parts, other information, ideas and sometimes people all flow through the network of customer–supplier relationships formed by all these operations. Supply side: An operation has its suppliers of parts, or information, or services. These suppliers themselves have their own suppliers who in turn could also have suppliers, and so on. Demand side: The operation has customers. These customers might not be the final consumers of the operation’s products or services; they might have their own set of customers.
- 7. The supply network perspective Supply side (First & Second Tier): Is a group of operations that directly supply the operation; these are often called first-tier suppliers. They are supplied by second-tier suppliers. However, some second-tier suppliers may also supply an operation directly, thus missing out a link in the network. Demand side (First & Second Tier): Of the network, ‘first-tier’ customers are the main customer group for the operation. These in turn supply ‘second-tier’ customers, although again the operation may at times supply second-tier customers directly. Immediate supply network: The suppliers and customers who have direct contact with an operation Total supply network: All the operations which form the network of suppliers’ suppliers and customers’ customers, etc.
- 8. Why consider the whole supply network? • There are three important reasons for taking a supply network perspective: • It helps an understanding of competitiveness. Immediate customers and immediate suppliers, quite understandably, are the main concern to competitively minded companies. Yet sometimes they need to look beyond these immediate contacts to understand why customers and suppliers act as they do. Any operation has only two options if it wants to understand its ultimate customers’ needs at the end of the network. It can rely on all the intermediate customers and customers’ customers, etc., which form the links in the network between the company and its end-customers. Alternatively, it can look beyond its immediate customers and suppliers. Relying on one’s immediate network is seen as putting too much faith in someone else’s judgment of things which are central to an organization’s own
- 9. Why consider the whole supply network? It helps identify significant links in the network. The key to understanding supply networks lies in identifying the parts of the network which contribute to those performance objectives valued by end-customers. Any analysis of networks must start, therefore, by understanding downstream end of the network. After this, the upstream parts of the network which contribute most to end-customer service will need to be identified. But they will not be equally significant. For example, the important end-customers for domestic plumbing parts and appliances are the installers and service companies that deal directly with domestic consumers. They are supplied by ‘stock holders’ which must have all parts in stock and deliver them fast. Suppliers of parts to the stock holders can best contribute to their end-customers’ competitiveness partly by offering a short delivery lead time but mainly through dependable delivery. The key players in this example are the stock holders. The best way of winning end-customer business in this case is to give the stock holder prompt delivery which helps keep costs down while providing high availability of parts.
- 10. Why consider the whole supply network? • It helps focus on long-term issues. There are times when circumstances render parts of a supply network weaker than its adjacent links. A major machine breakdown, for example, or a labour dispute might disrupt a whole network. Should its immediate customers and suppliers exploit the weakness to enhance their own competitive position, or should they tolerate the problems, and hope the customer or supplier will eventually recover? A long-term supply-network view would be to weigh the relative advantages to be gained from assisting or replacing the weak link.
- 11. Design decisions in supply networks • The supply-network view is useful because it prompts three particularly important design decisions. These are the most strategic of all the design decisions. – Outsourcing Vertical integration Do or buy – Location
- 12. Outsourcing Vertical integration Do or buy • How should the network be configured? – This means, first, how can an operation influence the shape which the network might take? – Second, how much of the network should the operation own? – This may be called the outsourcing, vertical integration or do-or-buy decision.
- 14. Location • Where should each part of the network be located? – If the home ware company builds a new factory, should it be close to its suppliers or close to its customers, or somewhere in between? – This decision is called the operations location decision.
- 15. Reasons for location decisions 1. Changes in demand: A change in location may be prompted by customer demand shifting. 2. Changes in supply: The other stimulus for relocation is changes in the cost, or availability 3. Expansion purposes: Firms such as banks, fast-food chains etc. view locations as part of marketing strategy, and they look for locations that will help them to expand their markets. Basically, the location decision in these cases reflect the addition of new locations to an existing system. 4. Depletion of basic inputs: Some firms face location decisions through depletion of basic inputs. For example, fishing, logging operations are often faced to relocate due to the temporary exhaustion of fish or forests at a given location.
- 16. The objectives of the location decision Spatially variable costs the spatially variable costs of the operation (spatially variable means that something changes with geographical location); The service the operation is able to provide to its customers; The revenue potential of the operation.
- 18. 1. Nearness to the Raw Material: Firms locate near or at the source of raw material for three primary reasons: Necessity Perishability Transportation costs Mining operations, farming, forestry, and fishing fall under necessity. Firms involved in canning or freezing of fresh fruits and vegetables, processing of dairy products, baking, and so on, must consider perishability when considering location. Transportation costs are important in industries where processing eliminates much of the bulk connected with a raw material, making it less to transport the product or material after processing. Factors that affect Location Decisions
- 19. 2. Nearness to Markets: Markets may be nation-wide or local, production may be centralized in one or several plants; or production may be decentralized in many plants near the consumer. This decision depends upon the nature of the product. Industries in which production may be centralized, even though distribution is nation-wide include, watches, clocks, jewelry, fountain pens, books , magazines etc. In such industries the product is relatively light in weight, and labor is an important percentage of the cost. Some processing plants make a fragile or perishable product. Such industries profit by being near the consumer. Moreover, industries which produce goods in accordance with the specifications of consumers may profit by locating near the market. Factors that affect Location Decisions
- 20. 3. Labor Conditions: The number of workers and the particular crafts or skills needed should be considered in relation to the labor available in an area. A factory which uses low-paid labor should be located near the workers. Labor cost is affected by the: a. Efficiency of labor b. The number of unemployed workers in an area c. The extent of unionization d. The level of wages e. The cost of living f. The housing conditions Factors that affect Location Decisions
- 21. 4. Cost of Land: The cost of land is an important factor in choosing between a city location and one in a town or suburb. Suitable land is limited along some water or lake fronts and a lack of adequate space may force the company to choose a multistory building when other considerations indicate that a single-story building would be more desirable. Many companies require space for parking facilities, adequate light and air, and protection against undesirable neighbours. Factors that affect Location Decisions
- 22. 5. Future plans for expansion: Space for possible expansion should also be available. A location should not be chosen merely because land or building is for sale at what appears to be an attractive price. Location is not easily changed, and a poor location may burden a company permanently with heavy fixed charges. Moreover, while deciding about the appropriate location of land considerations should be put forth with respect to the expansion in terms of market and volume as well. 6. Power and fuel: Fuel and power are important costs to factories requiring a great deal of power. In developing countries it has been ever difficult to curtail power costs. The dependability of the power supply is exceedingly important for some industries. Both oil and gas have advantages in cleanliness and labor costs. Factors that affect Location Decisions
- 23. 7. Water Supply: Many modern industries generate large amount of heat and use water for cooling as well as other purposes. Air- conditioning systems for public buildings use large amounts of water, and a large plant can use up the surplus water supply of a small community and cause a deficit. 8. Civic Values: Numerous features of community and civic life contribute to the desirability of the city or town as a place for employees to live. If the city provides many services for its residents, the workers and his family may receive benefits which are properly a part of his real wage. Moreover, a company that moves into an area with a new plant should consider not only the facilities available but also the demands that the company and its employees will make upon such community services as schools, libraries, hospitals, parking parks etc. Factors that affect Location Decisions
- 24. 9. Taxes: Tax rates differ from the one locality to another, and some states depend more upon certain kinds of taxes than do others. Some tax advantage may be gained by a small town location as compared with an urban site, but in the choice of a small-town or urban location other factors might be even more important. 10. Climate: Climate is usually not a deciding factor, although workers are presumed to do better work in some climates that in others. Extremely cold, hot, rainy or dry climates are not desirable. The most important question is whether the workers would object to live in an area. For making good conditions possible air conditioning or heating system can be installed. Factors that affect Location Decisions
- 25. Location techniques • Weighted-score method • The centre-of-gravity method
- 26. Weighted-score method • The procedure involves, first of all, identifying the criteria which will be used to evaluate the various locations. • Second, it involves establishing the relative importance of each criterion and giving weighting factors to them. • Third, it means rating each location according to each criterion. The scale of the score is arbitrary. In our example we shall use 0 to 100, where 0 represents the worst possible score and 100 the best.
- 27. Worked example • In order to choose a site it has decided to evaluate all options against a number of criteria, as follows: – the cost of the site; – the rate of local property taxation; – the availability of suitable skills in the local labour force; – the site’s access to the motorway network; – the site’s access to the airport; – the potential of the site for future expansion.
- 29. Sr. No Facilities Weighted Point Lahore Faisalabad Multan 1 Raw Material 20 7 17 17 2 Market 10 8 6 5 3 Plan of Expansion 10 4 8 8 4 Labor Supply 20 8 15 10 5 Land 5 1 4 4 6 Civic Conditions 10 8 6 4 7 Safety Measures 15 8 11 12 8 Taxes Advantage 25 - 25 25 9 Climate 15 10 12 5 10 Fuel & Power 20 15 13 10 Total: 150 71 115 100 % 100 % 47.3 % 76.6 % 66.6 % Choice of Town or City Through Weighted Index
- 30. The centre-of-gravity method • The centre-of-gravity method is used to find a location which minimizes transportation costs. • It is based on the idea that all possible locations have a ‘value’ which is the sum of all transportation costs to and from that location. • The best location, the one which minimizes costs, is represented by what in a physical analogy would be the weighted centre of gravity of all points to and from which goods are transported.
- 31. Worked example
Editor's Notes
- Economies of scale( minimum cost with maximum production), economies of scope (aikk tym mein different countries ko mall supply kare , DG cement) Financial economy of scale(maximum time period pay back with minimum interest) Marketing economies of scale(aik model sy ad bnao n different countries mein chala do) Managerial economies of scale ( minimum salaries maximum work) Technology economies of scale (technology out put maximum with minimum cost) Purchasing economies of scale ( purchase in bulk)
- Changing the shape of the supply network Even when an operation does not directly own, or even control, other operations in its network, it may still wish to change the shape of the network. This involves attempting to manage network behaviour by reconfiguring the network so as to change the scope of the activities performed in each operation and the nature of the relationships between them. Reconfiguring a supply network sometimes involves parts of the operation being merged – not necessarily in the sense of a change of ownership of any parts of an operation, but rather in the way responsibility is allocated for carrying out activities. The most common example of network reconfiguration has come through the many companies that have recently reduced the number of direct suppliers. The complexity of dealing with many hundreds of suppliers may both be expensive for an operation and (sometimes more important) prevent the operation from developing a close relationship with a supplier. It is not easy to be close to hundreds of different suppliers. Disintermediation Another trend in some supply networks is that of companies within a network bypassing customers or suppliers to make contact directly with customers’ customers or suppliers’ suppliers. ‘Cutting out the middlemen’ in this way is called disintermediation. An obvious example of this is the way the Internet has allowed some suppliers to ‘disintermediate’ traditional retailers in supplying goods and services to consumers. So, for example, many services in the travel industry that used to be sold through retail outlets (travel agents) are now also available direct from the suppliers. The option of purchasing the individual components of a vacation through the web sites of the airline, hotel, car hire company, etc., is now easier for consumers. Of course, they may still wish to purchase an ‘assembled’ product from retail travel agents which can have the advantage of convenience. Nevertheless the process of disintermediation has developed new linkages in the supply network. Co-opetition One approach to thinking about supply networks sees any business as being surrounded by four types of players: suppliers, customers, competitors and complementors. Complementors enable one’s products or services to be valued more by customers because they can also have the Outsourcing Vertical integration Do or buy Location Long-term capacity management Disintermediation complementor’s products or services, as opposed to when they have yours alone. Competitors are the opposite: they make customers value your product or service less when they can have their product or service, rather than yours alone. Competitors can also be complementors and vice versa. For example, adjacent restaurants may see themselves as competitors for customers’ business. A customer standing outside and wanting a meal will choose between the two of them. Yet, in another way they are complementors. Would that customer have come to this part of town unless there was more than one restaurant to choose from? Restaurants, theatres, art galleries and tourist attractions generally, all cluster together in a form of cooperation to increase the total size of their joint market. It is important to distinguish between the way companies cooperate in increasing the total size of a market and the way in which they then compete for a share of that market. Customers and suppliers, it is argued, should have ‘symmetric’ roles. Harnessing the value of suppliers is just as important as listening to the needs of customers. Destroying value in a supplier in order to create it in a customer does not increase the value of the network as a whole. So, pressurizing suppliers will not necessarily add value. In the long term it creates value for the total network to find ways of increasing value for suppliers and well as customers. All the players in the network, whether they are customers, suppliers, competitors or complementors, can be both friends and enemies at different times. The term used to capture this idea is ‘co-opetition’.2 In-house or outsource? Do or buy? The vertical integration decision No single business does everything that is required to produce its products and services. Bakers do not grow wheat or even mill it into flour. Banks do not usually do their own credit checking: they retain the services of specialist credit checking agencies that have the specialized information systems and expertise to do it better. This process is called ‘outsourcing’ and has become an important issue for most businesses. This is because, although most companies have always outsourced some of their activities, a larger proportion of direct activities are now being bought from suppliers. Also many indirect processes are now being outsourced. This is often referred to as ‘business process outsourcing’ (BPO). Financial service companies in particular are starting to outsource some of their more routine back-office processes. In a similar way many processes within the human resource function from simply payroll services through to more complex training and development processes, are being outsourced to specialist companies. The processes may still be physically located where they were before, but the staff and technology are managed by the outsourcing service provider. The reason for doing this is often primarily to reduce cost. However, there can sometimes also be significant gains in the quality and flexibility of service offered. ‘People talk a lot about looking beyond cost cutting when it comes to outsourcing companies’ human resource functions’, says Jim Madden, CEO of Exult, the California-based specialist outsourcing company, ‘I don’t believe any company will sign up for this [outsourcing] without cost reduction being part of it, but for the clients whose human resource functions we manage, such as BP, and Bank of America, it is not just about saving money.’ The outsourcing debate is just part of a far larger issue which will shape the fundamental nature of any business. Namely, what should the scope of the business be? In other words, what should it do itself and what should it buy in? This is often referred to as the ‘do-or-buy decision’ when individual components or activities are being considered, or ‘vertical integration’ when it is the ownership of whole operations that is being decided. Vertical integration is the extent to which an organization owns the network of which it is a part. It usually involves an organization assessing the wisdom of acquiring suppliers or customers. Vertical integration can be defined in terms of three factors. 1 The direction of vertical integration. Should an operation expand by buying one of its suppliers or by buying one of its customers? The strategy of expanding on the supply side of the network is sometimes called ‘backward’ or ‘upstream’ vertical integration, Co-opetition and expanding on the demand side is sometimes called ‘forward’ or ‘downstream’ vertical integration. 2 The extent of vertical integration. How far should an operation take the extent of its vertical integration? Some organizations deliberately choose not to integrate far, if at all, from their original part of the network. Alternatively, some organizations choose to become very vertically integrated. 3 The balance among stages. How exclusive should the relationship be between operations. A totally balanced network relationship is one where one operation produces only for the next stage in the network and totally satisfies its requirements. Less than full balance allows each operation to sell its output to other companies or to buy in some of its supplies from other companies. Making the outsourcing / vertical integration decision Whether it is referred to as do-or-buy, vertical integration or no vertical integration, in-house or outsourced supply, the choice facing operations is rarely simple. Organizations in different circumstances with different objectives are likely to take different decisions. Yet the question itself is relatively simple, even if the decision itself is not: ‘Does in-house or outsourced supply in a particular set of circumstances give the appropriate performance objectives that it requires to compete more effectively in its markets?’ For example, if the main performance objectives for an operation are dependable delivery and meeting short-term changes in customers’ delivery requirements, the key question should be: ‘How does in-house or outsourcing give better dependability and delivery flexibility performance?’ This means judging two sets of opposing factors – those which give the potential to improve performance and those which work against this potential being realized. Table 6.1 summarizes some arguments for in-house supply and outsourcing in terms of each performance objective.
- Not all operations can logically justify their location. Some are where they are for historical reasons. Yet even the operations that are ‘there because they’re there’ are implicitly making a decision not to move. Presumably their assumption is that the cost and disruption involved in changing location would outweigh any potential benefits of a new location. Two stimuli often cause organizations to change locations: changes in demand for their goods and services, and changes in supply of their inputs. Changes in demand. A change in location may be prompted by customer demand shifting. For example, as garment manufacture moved to Asia, suppliers of zips, threads, etc. started to follow them. Changes in the volume of demand can also prompt relocation. To meet higher demand, an operation could expand its existing site, or choose a larger site in another location, or keep its existing location and find a second location for an additional operation; the last two options will involve a location decision. High-visibility operations may not have the choice of expanding on the same site to meet rising demand. A dry cleaning service may attract only marginally more business by expanding an existing site because it offers a local, and therefore convenient, service. Finding a new location for an additional operation is probably its only option for expansion. Changes in supply. The other stimulus for relocation is changes in the cost, or availability, of the supply of inputs to the operation. For example, a mining or oil company will need to relocate as the minerals it is extracting become depleted. A manufacturing company might choose to relocate its operations to a part of the world where labour costs are low, because the equivalent resources (people) in its original location have become relatively expensive. Sometimes a business might choose to relocate to release funds if the value of the land it occupies is worth more than an alternative, equally good, location.
- Supply-side influences Labour costs. The costs of employing people with particular skills can vary between different areas in any country, but are likely to be more significant when international comparisons are made. Labour costs can be expressed in two ways. The ‘hourly cost’ is what firms have to pay workers on average per hour. However, the ‘unit cost’ is an indication of the labour cost per unit of production. This includes the effects both of productivity differences between countries and of differing currency exchange rates. Exchange rate variation can cause unit costs to change dramatically over time. Yet in spite of this, labour costs exert a major influence on the location decision, especially in some industries such as clothing, where labour costs as a proportion of total costs are relatively high. Land costs. The cost of acquiring the site itself is sometimes a relevant factor in choosing a location. Land and rental costs vary between countries and cities. At a more local level, land costs are also important. A retail operation, when choosing ‘high-street’ sites, will pay a particular level of rent only if it believes it can generate a certain level of revenue from the site. Energy costs. Operations which use large amounts of energy, such as aluminium smelters, can be influenced in their location decisions by the availability of relatively inexpensive energy. This may be direct, as in the availability of hydroelectric generation in an area, or indirect, such as low-cost coal which can be used to generate inexpensive electricity. Transportation costs. Transportation costs include both the cost of transporting inputs from their source to the site of the operation, and the cost of transporting goods from the site to customers. Whereas almost all operations are concerned to some extent with the former, not all operations transport goods to customers; rather, customers come to them (for example, hotels). Even for operations that do transport their goods to customers (most manufacturers, for example), we consider transportation as a supply-side factor because as location changes, transportation costs also change. Proximity to sources of supply dominates the location decision where the cost of transporting input materials is high or difficult. Food processing and other agriculture-based activities, for example, are often carried out close to growing areas. Conversely, transportation to customers dominates location decisions where this is expensive or difficult. Civil engineering projects, for example, are constructed mainly where they will be needed. Community factors. Community factors are those influences on an operation’s costs which derive from the social, political and economic environment of its site. These include: ● local tax rates ● capital movement restrictions ● government financial assistance ● government planning assistance ● political stability ● local attitudes to ‘inward investment’ ● language ● local amenities (schools, theatres, shops, etc.) ● availability of support services ● history of labour relations and behaviour ● environmental restrictions and waste disposal ● planning procedures and restrictions. Demand-side influences Labour skills. The abilities of a local labour force can have an effect on customer reaction to the products or services which the operation produces. For example, ‘science parks’ are usually located close to universities because they hope to attract companies that are interested in using the skills available at the university. The suitability of the site itself. Different sites are likely to have different intrinsic characteristics which can affect an operation’s ability to serve customers and generate revenue. For example, the location of a luxury resort hotel which offers up-market holiday accommodation is very largely dependent on the intrinsic characteristics of the site. Located next to the beach, surrounded by waving palm trees and overlooking a picturesque bay, the hotel is very attractive to its customers. Move it a few kilometres away into the centre of an industrial estate and it rapidly loses its attraction. Image of the location. Some locations are firmly associated in customers’ minds with a particular image. Suits from Savile Row (the centre of the up-market bespoke tailoring district in London) may be no better than high-quality suits made elsewhere but, by locating its operation there, a tailor has probably enhanced its reputation and therefore its revenue. The product and fashion design houses of Milan and the financial services in the City of London also enjoy a reputation shaped partly by that of their location. Convenience for customers. Of all the demand-side factors, this is, for many operations, the most important. Locating a general hospital, for instance, in the middle of the countryside may have many advantages for its staff, and even perhaps for its costs, but it clearly would be very inconvenient to its customers. Those visiting the hospital would need to travel long distances. Because of this, general hospitals are located close to centres of demand. Similarly with other public services and restaurants, stores, banks, petrol filling stations etc., location determines the effort to which customers have to go in order to use the operation. Locations which offer convenience for the customer are not always obvious. In the 1950s Jay Pritzker called into a hotel at Los Angeles airport for a coffee. He found that, although the hotel was full, it was also for sale. Clearly there was customer demand but presumably the hotel could not make a profit. That is when he got the idea of locating luxury hotels which could command high revenues at airports where there was always demand. He called his hotel chain Hyatt; it is now one of the best-known hotel chains in the world.
- The centre-of-gravity method is used to find a location which minimizes transportation costs. It is based on the idea that all possible locations have a ‘value’ which is the sum of all transportation costs to and from that location. The best location, the one which minimizes costs, is represented by what in a physical analogy would be the weighted centre of gravity of all points to and from which goods are transported. So, for example, two suppliers, each sending 20 tonnes of parts per month to a factory, are located at points A and B. The factory must then assemble these parts and send them to one customer located at point C. Since point C receives twice as many tonnes as points A and B (transportation cost is assumed to be directly related to the tonnes of goods shipped) then it has twice the weighting of point A or B. The lowest transportation cost location for the factory is at the centre of gravity of a (weightless) board where the two suppliers’ and one customer’s locations are represented to scale and have weights equivalent to the weightings of the number of tonnes they send or receive.