Chapter 5 exercises

Chapter 5 • Network Design in the Supply Chain 163

6. Consider a firm such as Apple or Dell, with few production 7. Consider a firm such as Ford, with more than 150 facilities
facilities worldwide. List the pros and cons of this approach worldwide. List the pros and cons of having many facilities
and why it may or may not be suitable for the computer and why this model may or may not be suitable for the auto-
industry. mobile industry.

Exercises
1. SC Consulting, a supply chain consulting firm, must decide b. If 10 consultants are to be assigned to a home office, at
on the location of its home offices. Its clients are located pri- most, where should the offices be set up? How many con-
marily in the 16 states listed in Table 5-5. There are four sultants should be assigned to each office? What is the
potential sites for home offices: Los Angeles, Tulsa, Denver, annual cost of this network?
and Seattle. The annual fixed cost of locating an office in Los c. What do you think of a rule by which all consulting proj-
Angeles is $165,428, Tulsa is $131,230, Denver is $140,000, ects out of a given state are assigned to one home office?
and Seattle is $145,000. The expected number of trips to each How much is this policy likely to add to cost compared to
state and the travel costs from each potential site are shown in allowing multiple offices to handle a single state?
Table 5-5. Each consultant is expected to take at most 25 trips 2. DryIce, Inc., is a manufacturer of air conditioners that has
each year. seen its demand grow significantly. The company anticipates
a. If there are no restrictions on the number of consultants at nationwide demand for the next year to be 180,000 units in
a site and the goal is to minimize costs, where should the the South, 120,000 units in the Midwest, 110,000 units in the
home offices be located and how many consultants should East, and 100,000 units in the West. Managers at DryIce are
be assigned to each office? What is the annual cost in designing the manufacturing network and have selected four
terms of the facility and travel? potential sites—New York, Atlanta, Chicago, and San Diego.

TABLE 5-5 Travel Costs and Number of Trips for SC Consulting

Travel Costs ($)

Number
State Los Angeles Tulsa Denver Seattle of Trips
Washington 150 250 200 25 40
Oregon 150 250 200 75 35
California 75 200 150 125 100
Idaho 150 200 125 125 25
Nevada 100 200 125 150 40
Montana 175 175 125 125 25
Wyoming 150 175 100 150 50
Utah 150 150 100 200 30
Arizona 75 200 100 250 50
Colorado 150 125 25 250 65
New Mexico 125 125 75 300 40
North Dakota 300 200 150 200 30
South Dakota 300 175 125 200 20
Nebraska 250 100 125 250 30
Kansas 250 75 75 300 40
Oklahoma 250 25 125 300 55
164 Chapter 5 • Network Design in the Supply Chain

TABLE 5-6 Production and Transport Costs for DryIce, Inc.

New York Atlanta Chicago San Diego

Annual fixed cost $6 million $5.5 million $5.6 million $6.1 million
of 200,000 plant
Annual fixed cost $10 million $9.2 million $9.3 million $10.2 million
of 400,000 plant
East $211 $232 $238 $299
South $232 $212 $230 $280
Midwest $240 $230 $215 $270
West $300 $280 $270 $225

TABLE 5-7 Capacity, Demand, Production, and Transportation Costs for Sunchem
North South Capacity Production
America Europe Japan America Asia Tons/Year Cost/Ton

United States $600 $1,300 $2,000 $1,200 $1,700 185 $10,000

Germany $1,300 $600 $1,400 $1,400 $1,300 475 15,000 euro
Japan $2,000 $1,400 $300 $2,100 $900 50 1,800,000 yen
Brazil $1,200 $1,400 $2,100 $800 $2,100 200 13,000 real
India $2,200 $1,300 $1,000 $2,300 $800 80 400,000 rupees
Demand 270 200 120 190 100
(tons/year)

Plants could have a capacity of either 200,000 or 400,000 c. Can adding 10 tons of capacity in any plant reduce costs?
units. The annual fixed costs at the four locations are shown d. How should Sunchem account for the fact that exchange
in Table 5-6, along with the cost of producing and shipping rates fluctuate over time?
an air conditioner to each of the four markets. Where should 4. Sleekfon and Sturdyfon are two major cell phone manufac-
DryIce build its factories and how large should they be? turers that have recently merged. Their current market sizes
3. Sunchem, a manufacturer of printing inks, has five manufac- are as shown in Table 5-9. All demand is in millions of units.
turing plants worldwide. Their locations and capacities are Sleekfon has three production facilities in Europe (EU),
shown in Table 5-7 along with the cost of producing 1 ton of North America, and South America. Sturdyfon also has three
ink at each facility. The production costs are in the local cur- production facilities in Europe (EU), North America, and the
rency of the country where the plant is located. The major
markets for the inks are North America, South America, TABLE 5-8 Anticipated Exchange Rates for the
Europe, Japan, and the rest of Asia. Demand at each market Next Year
is shown in Table 5-7. Transportation costs from each plant to
each market in U.S. dollars are shown in Table 5-7. Manage- US$ Euro Yen Real Rupee
ment must come up with a production plan for the next year. US$ 1.000 1.993 107.7 1.78 43.55
a. If exchange rates are expected as in Table 5-8, and no
Euro 0.502 1 54.07 0.89 21.83
plant can run below 50 percent of capacity, how much
should each plant produce and which markets should each Yen 0.0093 0.0185 1 0.016 0.405
plant supply? Real 0.562 1.124 60.65 1 24.52
b. If there are no limits on the amount produced in a plant,
how much should each plant produce? Rupee 0.023 0.046 2.47 0.041 1
 Chapter 5 • Network Design in the Supply Chain 165

TABLE 5-9 Global Demand and Duties for Sleekfon and Sturdyfon
Europe Europe Rest of Asia/
Market N. America S. America (EU) (Non-EU) Japan Australia Africa
Sleekfon demand 10 4 20 3 2 2 1
Sturdyfon demand 12 1 4 8 7 3 1
Import duties (%) 3 20 4 15 4 22 25

TABLE 5-10 Plant Capacities and Costs for Sleekfon and Sturdyfon
Capacity Fixed Cost/Year Variable Cost/Unit
Sleekfon Europe (EU) 20 100 6.0
N. America 20 100 5.5
S. America 10 60 5.3
Sturdyfon Europe (EU) 20 100 6.0
N. America 20 100 5.5
Rest of Asia 10 50 5.0

rest of Asia/Australia. The capacity (in millions of units), The merged company has estimated that scaling back a
annual fixed cost (in millions of $), and variable production 20-million-unit plant to 10 million units saves 30 percent in
costs ($ per unit) for each plant are as shown in Table 5-10. fixed costs. Variable costs at a scaled-back plant are
Transportation costs between regions are as shown in unaffected. Shutting a plant down (either 10 million or 20
Table 5-11. All transportation costs are shown in dollars per unit. million units) saves 80 percent in fixed costs. Fixed costs are
Duties are applied on each unit based on the fixed cost only partially recovered because of severance and other costs
per unit capacity, variable cost per unit, and transportation associated with a shutdown.
cost. Thus, a unit currently shipped from North America to a. What is the lowest cost achievable for the production and
Africa has a fixed cost per unit of capacity of $5.00, a vari- distribution network prior to the merger? Which plants
able production cost of $5.50, and a transportation cost of serve which markets?
$2.20. The 25 percent import duty is thus applied on $12.70 b. What is the lowest cost achievable for the production and
(5.00 + 5.50 + 2.20) to give a total cost on import of $15.88. distribution network after the merger if none of the plants
For the questions that follow, assume that market demand is is shut down? Which plants serve which markets?
as in Table 5-9.

TABLE 5-11 Transportation Costs Between Regions ($ per Unit)

Europe Europe Rest of Asia/
N. America S. America (EU) (Non-EU) Japan Australia Africa
N. America 1.00 1.50 1.50 1.80 1.70 2.00 2.20
S. America 1.50 1.00 1.70 2.00 1.90 2.20 2.20
Europe (EU) 1.50 1.70 1.00 1.20 1.80 1.70 1.40
Europe (Non-EU) 1.80 2.00 1.20 1.00 1.80 1.60 1.50
Japan 1.70 1.90 1.80 1.80 1.00 1.20 1.90
Rest of Asia/Australia 2.00 2.20 1.70 1.60 1.20 1.00 1.80
Africa 2.20 2.20 1.40 1.50 1.90 1.80 1.00
166 Chapter 5 • Network Design in the Supply Chain

c. What is the lowest cost achievable for the production and

TABLE 5-12 Production and Transport Cost
distribution network after the merger if plants can be
(Thousands of Rupees) per Refrigerator
scaled back or shut down in batches of 10 million units of
capacity? Which plants serve which markets? North East West South
d. How is the optimal network configuration affected if all
duties are reduced to 0? Chennai 20 19 17 15
e. How should the merged network be configured? Delhi 15 18 17 20
5. Return to the Sleekfon and Sturdyfon data in Exercise 4. Kolkata 18 15 20 19
Management has estimated that demand in global markets is
likely to grow. North America, Japan, and Europe (EU) are Mumbai 17 20 15 17
relatively saturated and expect no growth. South America,
Africa, and Europe (Non-EU) markets expect a growth of 20
percent. The rest of Asia/Australia anticipates a growth of
200 percent. 10 years—that is, years 6 to 15. The problem can now be
a. How should the merged company configure its network to solved for different discount factors. To begin with, assume
accommodate the anticipated growth? What is the annual a discount factor of 0.2—that is, 1 rupee spent next year is
cost of operating the network? worth 10.20.8 rupee this year.
b. There is an option of adding capacity at the plant in the a. How should the production network for the company
rest of Asia/Australia. Adding 10 million units of capacity evolve over the next five years?
incurs an additional fixed cost of $40 million per year. b. How does your answer change if the anticipated growth is
Adding 20 million units of additional capacity incurs an 15 percent? 25 percent?
additional fixed cost of $70 million per year. If shutdown c. How does your decision change for a discount factor of
costs and duties are as in Exercise 4, how should the 0.25? 0.15?
merged company configure its network to accommodate d. What investment strategy do you recommend for the
anticipated growth? What is the annual cost of operating company?
the new network? 7. Blue Computers, a major server manufacturer in the United
c. If all duties are reduced to 0, how does your answer to States, currently has plants in Kentucky and Pennsylvania.
Exercise 5(b) change? The Kentucky plant has a capacity of 1 million units a year,
d. How should the merged network be configured given and the Pennsylvania plant has a capacity of 1.5 million
the option of adding to the plant in the rest of Asia/ units a year. The firm divides the United States into five
Australia? markets: northeast, southeast, midwest, south, and west.
6. StayFresh, a manufacturer of refrigerators in India, has two Each server sells for $1,000. The firm anticipates a 50 per-
plants—one in Mumbai and the other in Chennai. Each plant cent growth in demand (in each region) this year (after
has a capacity of 300,000 units. The two plants serve the which demand will stabilize) and wants to build a plant
entire country, which is divided into four regional markets: with a capacity of 1.5 million units per year to accommo-
the north, with a demand of 100,000 units; the west, with a date the growth. Potential sites being considered are in
demand of 150,000 units; the south, with a demand of North Carolina and California. Currently the firm pays fed-
150,000 units; and the east, with a demand of 50,000 units. eral, state, and local taxes on the income from each plant.
Two other potential sites for plants include Delhi and Kolk- Federal taxes are 20 percent of income, and all state and
ata. The variable production and transport costs (in thousands local taxes are 7 percent of income in each state. North Car-
of rupees; 1 U.S. dollar is worth about 65 rupees) per refrig- olina has offered to reduce taxes for the next 10 years from
erator from each potential production site to each market are 7 percent to 2 percent. Blue Computers would like to take
as shown in Table 5-12. the tax break into consideration when planning its network.
StayFresh is anticipating a compounded growth in Consider income over the next 10 years in your analysis.
demand of 20 percent per year for the next five years and Assume that all costs remain unchanged over the 10 years.
must plan its network investment decisions. Demand is Use a discount factor of 0.1 for your analysis. Annual fixed
anticipated to stabilize after five years of growth. Capacity costs, production and shipping costs per unit, and current
can be added in increments of either 150,000 or 300,000 regional demand (before the 50 percent growth) are shown
units. Adding 150,000 units of capacity incurs a one-time in Table 5-13.
cost of 2 billion rupees, whereas adding 300,000 units of a. If Blue Computers sets an objective of minimizing total
capacity incurs a one-time cost of 3.4 billion rupees. fixed and variable costs, where should it build the new
Assume that StayFresh plans to meet all demand (prices plant? How should the network be structured?
are sufficiently high) and that capacity for each year must b. If Blue Computers sets an objective of maximizing after-
be in place by the beginning of the year. Also assume that tax profits, where should it build the new plant? How
the cost for the fifth year will continue for the next should the network be structured?
 Chapter 5 • Network Design in the Supply Chain 167

TABLE 5-13 Variable Production and Shipping Costs for Blue Computers
Variable Production and Shipping Cost ($/Unit)
Annual Fixed
Northeast Southeast Midwest South West Cost (Million $)
Kentucky 185 180 175 175 200 150
Pennsylvania 170 190 180 200 220 200
N. Carolina 180 180 185 185 215 150
California 220 220 195 195 175 150
Demand (thousands of units/month) 700 400 400 300 600

TABLE 5-14 Capacity, Cost, and Demand Data for Hot&Cold and CaldoFreddo
Variable Production and Shipping Costs
Annual
North East South West Capacity Fixed Cost
Hot&Cold France 100 110 105 100 50 1,000
Germany 95 105 110 105 50 1,000
Finland 90 100 115 110 40 850
Demand 30 20 20 35
CaldoFreddo U.K. 105 120 110 90 50 1,000
Italy 110 105 90 115 60 1,150
Demand 15 20 30 20

8. Hot&Cold and CaldoFreddo are two European manufactur- a. Before the merger, what is the optimal network for each
ers of home appliances that have merged. Hot&Cold has of the two firms if their goal is to minimize costs? What is
plants in France, Germany, and Finland, whereas Caldo- the optimal network if the goal is to maximize after-tax
Freddo has plants in the United Kingdom and Italy. The profits?
European market is divided into four regions: north, east, b. After the merger, what is the minimum cost configuration
west, and south. Plant capacities (millions of units per year), if none of the plants is shut down? What is the configura-
annual fixed costs (millions of euros per year), regional tion that maximizes after-tax profits if none of the plants
demand (millions of units), and variable production and is shut down?
shipping costs (euros per unit) are as shown in Table 5-14. c. After the merger, what is the minimum cost configuration
Each appliance sells for an average price of 300 euros. if plants can be shut down (assume that a shutdown saves
All plants are currently treated as profit centers, and the 100 percent of the annual fixed cost of the plant)? What is
company pays taxes separately for each plant. Tax rates in the the configuration that maximizes after-tax profits?
various countries are as follows: France, 0.25; Germany,
0.25; Finland, 0.3; UK, 0.2; and Italy, 0.35.

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Location Decisions.” Industrial Development (May–June Chain Management Review (September 2008): 33–37.
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Management Review (May–June 2008): 25–31.

CasE stuDy
Managing Growth at SportStuff.com
In December 2008, Sanjay Gupta and his management Internet. The idea was well received in the marketplace,
team were busy evaluating the performance at Sport- demand grew rapidly, and, by the end of 2004, the com-
Stuff.com over the previous year. Demand had grown by pany had sales of $0.8 million. By this time, a variety of
80 percent. This growth, however, was a mixed blessing. new and used products were being sold, and the com-
The venture capitalists supporting the company were pany received significant venture capital support.
very pleased with the growth in sales and the resulting In June 2004, Sanjay leased part of a warehouse in
increase in revenue. Sanjay and his team, however, could the outskirts of St. Louis to manage the large amount of
clearly see that costs would grow faster than revenues if product being sold. Suppliers sent their product to the
demand continued to grow and the supply chain network warehouse. Customer orders were packed and shipped
was not redesigned. They decided to analyze the perfor- by UPS from there. As demand grew, SportStuff.com
mance of the current network to see how it could be leased more space within the warehouse. By 2007,
redesigned to best cope with the rapid growth antici- SportStuff.com leased the entire warehouse and orders
pated over the next three years. were being shipped to customers all over the United
States. Management divided the United States into six
SportStuff.com customer zones for planning purposes. Demand from
Sanjay Gupta founded SportStuff.com in 2004 with a each customer zone in 2007 was as shown in Table 5-15.
mission of supplying parents with more affordable sports Sanjay estimated that the next three years would see a
equipment for their children. Parents complained about growth rate of about 80 percent per year, after which
having to discard expensive skates, skis, jackets, and demand would level off.
shoes because children outgrew them rapidly. Sanjay’s
The Network Options
initial plan was for the company to purchase used equip-
ment and jackets from families and surplus equipment Sanjay and his management team could see that they
from manufacturers and retailers and sell these over the needed more warehouse space to cope with the antici-

TABLE 5-15 Regional Demand at SportStuff.com for 2007

Zone Demand in 2007 Zone Demand in 2007
Northwest 320,000 Lower Midwest 220,000
Southwest 200,000 Northeast 350,000
Upper Midwest 160,000 Southeast 175,000
 Chapter 5 • Network Design in the Supply Chain 169

TABLE 5-16 Fixed and Variable Costs of Potential Warehouses

Small Warehouse Large Warehouse

Fixed Cost Variable Cost Fixed Cost Variable Cost

Location ($/year) ($/Unit Flow) ($/year) ($/Unit Flow)
Seattle 300,000 0.20 500,000 0.20
Denver 250,000 0.20 420,000 0.20
St. Louis 220,000 0.20 375,000 0.20
Atlanta 220,000 0.20 375,000 0.20
Philadelphia 240,000 0.20 400,000 0.20

pated growth. One option was to lease more warehouse warehouse handling 1 million units per year incurred an
space in St. Louis itself. Other options included leas- inventory holding cost of $600,000 in the course of the
ing warehouses all over the country. Leasing a ware- year. If your version of Excel has problems solving the
house involved fixed costs based on the size of the nonlinear objective function, use the following inventory
warehouse and variable costs that depended on the costs:
quantity shipped through the warehouse. Four poten-
tial locations for warehouses were identified in Den- Range of F Inventory Cost
ver, Seattle, Atlanta, and Philadelphia. Leased 0–2 million $250,000Y + 0.310F
warehouses could be either small (about 100,000 sq. 2–4 million $530,000Y + 0.170F
ft.) or large (200,000 sq. ft.). Small warehouses could
4–6 million $678,000Y + 0.133F
handle a flow of up to 2 million units per year, whereas
large warehouses could handle a flow of up to 4 mil- More than 6 million $798,000Y + 0.113F
lion units per year. The current warehouse in St. Louis
was small. The fixed and variable costs of small and If you can handle only a single linear inventory
large warehouses in different locations are shown in cost, you should use $475,000Y + 0.165F. For each facil-
Table 5-16. ity, Y = 1 if the facility is used, 0 otherwise.
Sanjay estimated that the inventory holding costs SportStuff.com charged a flat fee of $3 per ship-
at a warehouse _ (excluding warehouse expense) was ment sent to a customer. An average customer order con-
about $600 √F where F is the number of units flowing tained four units. SportStuff.com, in turn, contracted
through the warehouse per year. This relationship is with UPS to handle all its outbound shipments. UPS
based on the theoretical observation that the inventory charges were based on both the origin and the destina-
held at a facility (not across the network) is proportional tion of the shipment and are shown in Table 5-17. Man-
to the square root of the throughput through the facility. agement estimated that inbound transportation costs for
As a result, aggregating throughput through a few facili- shipments from suppliers were likely to remain
ties reduces the inventory held as compared with disag- unchanged, no matter what warehouse configuration
gregating throughput through many facilities. Thus, a was selected.

TABLE 5-17 UPS Charges per Shipment (Four Units)

Northwest Southwest Upper Midwest Lower Midwest Northeast Southeast
Seattle $2.00 $2.50 $3.50 $4.00 $5.00 $5.50
Denver $2.50 $2.50 $2.50 $3.00 $4.00 $4.50
St. Louis $3.50 $3.50 $2.50 $2.50 $3.00 $3.50
Atlanta $4.00 $4.00 $3.00 $2.50 $3.00 $2.50
Philadelphia $4.50 $5.00 $3.00 $3.50 $2.50 $4.00
170 Chapter 5 • Network Design in the Supply Chain

Study Questions 3. How would your recommendation change if transportation

costs were twice those shown in Table 5-17?
1. What is the cost SportStuff.com incurs if all warehouses
leased are in St. Louis?
2. What supply chain network configuration do you recom-
mend for SportStuff.com? Why?

CasE stuDy
Designing the Production Network at CoolWipes
Matt O’Grady, vice president of supply chain at Cool- rently had one factory in Chicago that produced both
Wipes, thought that his current production and distribu- products for the entire country. The wipes line in the
tion network was not appropriate, given the significant Chicago facility had a capacity of 5 million units, an
increase in transportation costs over the past few years. annualized fixed cost of $5 million a year, and a vari-
Compared to when the company had set up its produc- able cost of $10 per unit. The ointment line in the Chi-
tion facility in Chicago, transportation costs had cago facility had a capacity of 1 million units, an
increased by a factor of more than four and were annualized fixed cost of $1.5 million a year, and a vari-
expected to continue growing in the next few years. A able cost of $20 per unit. The current transportation
quick decision on building one or more new plants could costs per unit (for both wipes and ointment) are shown
save the company significant amounts in transportation in Table 5-19.
expense in the future.
New Network Options
CoolWipes
Matt had identified Princeton, New Jersey; Atlanta; and
CoolWipes was founded in the late 1980s and produced Los Angeles as potential sites for new plants. Each new
baby wipes and diaper ointment. Demand for the two plant could have a wipes line, an ointment line, or both.
products was as shown in Table 5-18. The company cur- A new wipes line had a capacity of 2 million units, an

TABLE 5-18 Regional Demand at CoolWipes (in thousands)

Wipes Ointment Wipes Ointment
Zone Demand Demand Zone Demand Demand
Northwest 500 50 Lower Midwest 800 65
Southwest 700 90 Northeast 1,000 120
Upper Midwest 900 120 Southeast 600 70

TABLE 5-19 Transportation Costs per Unit

Upper Lower
Northwest Southwest Midwest Midwest Northeast Southeast
Chicago $6.32 $6.32 $3.68 $4.04 $5.76 $5.96
Princeton $6.60 $6.60 $5.76 $5.92 $3.68 $4.08
Atlanta $6.72 $6.48 $5.92 $4.08 $4.04 $3.64
Los Angeles $4.36 $3.68 $6.32 $6.32 $6.72 $6.60
 Chapter 5 • Network Design in the Supply Chain 171

annual fixed cost of $2.2 million, and a variable produc- included? Assume that the Chicago plant will be main-
tion cost of $10 per unit. A new ointment line had a tained at its current capacity but could be run at lower uti-
capacity of 1 million units, an annual fixed cost of $1.5 lization. Would your decision be different if transportation
million, and a variable cost of $20 per unit. The current costs are half of their current value? What if they were
double their current value?
transportation costs per unit are shown in Table 5-19.
3. If Matt could design a new network from scratch (assume
Matt had to decide whether to build a new plant and if
he did not have the Chicago plant but could build it at the
so, which production lines to put into the new plant. cost and capacity specified in the case), what production
network would you recommend? Assume that any new
Study Questions plants built besides Chicago would be at the cost and
1. What is the annual cost of serving the entire nation from capacity specified under the new network options. Would
Chicago? your decision be different if transportation costs were half
2. Do you recommend adding any plant(s)? If so, where of their current value? What if they were double their cur-
should the plant(s) be built and what lines should be rent value?