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Lowering Costs Through Distribution Networking Analysis

September 4, 2017

This is a re-purpose of an original article published in Industrial Management magazine, Sept 1997, VOL 30, #5

While my vision from 20 years ago was a bit off (when considering the Amazon Global Fulfillment Center Network), this article will help you understand the fundamentals of a distribution network analysis.

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Supply Chain Management, Demand Flow Leadership or Value Chain Analysis?  Whatever your philosophy the fundamental goal of lowering costs while improving customer satisfaction, and the core elements of Supplying, Procuring, Producing, Distributing, Retailing, and Consuming, Figure 1, basically remain the same. This case study provides insight and action into lowering costs in the distribution network of a national beverage producer.

Demand Flow

Figure 1  Demand Flow Network

Business designs go through cycles from value inflow to stability to value outflow. Value migrates from outmoded business designs to new ones better able to satisfy customers’ needs. A business design is the totality of how a company selects its customers, defines and differentiates its offerings, defines the tasks it will perform and those it will outsource, configures its resources, goes to market, creates utility for customers and capture profits.

A national beverage producer was in the midst of a value outflow transformation. Due to distribution costs escalating at a faster rate than revenues, and a cumbersome distribution network weighed down by exceptional growth and rapidly shifting market demands, a new network plan was needed to keep pace with the shifting market segments and maintain economical customer service levels. The company was working in a reactive mode in an effort to meet customer expectations by locating distribution facilities near each major customer as the market grew.

Their primary markets were in metropolitan areas east of the Mississippi and some smaller markets in the west. Production facilities were located in the Northeast, Southeast and South central. Additionally, products were subcontracted to vendors also in the northeast. At the time of the analysis, all production facilities were operating at near capacity and there were over 45 third party warehouses in-use throughout the country. These warehouses were used as points-of-distribution to the retailer.

Through growth market development and product proliferation, case sales volumes were expected to double in the five-year planning horizon. Although a majority of the sales came from the Northeast, this market segment was expected to grow by only 5% annually with a majority of this growth coming from new products. This significant overall growth would be lead by new marketing efforts and/or expansion into the Southeast, Midwest and West. As market tests were being conducted in these growth areas, distribution costs were automatically impacted as a majority of the existing points of distribution were located along the east coast serving the established markets in this area.

Inventory was managed through a paper-based intensive process decentralized among several points of distribution. The growth in sales had a significant impact on data processing lead times and was reflected by inaccurate and untimely information.

Strategic Distribution Network Planning

Distribution network planning is one of the main areas effecting the value chain. A distribution network plan is developed to meet a specific set of requirements over a given planning horizon. A good plan will determine the optimal network to provide the customer with the right goods in the right quantity at the right place at the right time, and to minimize the total distribution cost. As the number of warehouses increases, delivery cost decreases and warehouse cost increases. This is shown in a simplified manner in Figure 2. The opposite is also true;  As the number of warehouses decreases, the delivery cost increases. Therefore, to minimize total distribution cost it is important to find the best balance of warehouses and transportation cost.

Cost to Serve Curve

FIGURE 2 Simplified Total Cost Model

The objective of distribution network planning is to develop a plan indicating the most economical way to ship and receive product while maintaining or increasing customer service requirements; simply put, a plan to maximize profits and optimize service. Distribution network planning may address the following questions:

  1. How many distribution centers should exist?
  2. Where should the distribution center(s) be located?
  3. How much inventory should be stocked at each distribution center?
  4. What customers should be serviced by each distribution center?
  5. How should the customers order from the distribution centers?
  6. How should the distribution centers order from vendors?
  7. How frequently should shipments be made to each customer?
  8. What should the service levels be?
  9. What transportation methods should be utilized?

Case Study

Prior to the analysis, a detailed market analysis was performed reflecting the current sales growth expectations and the new product impact by market segment. Historical cost data was collected and used to develop an economic baseline. This information included, TL/LTL percentages, Route costs, Third Party Storage Fees, etc. Under the existing system, significant costs were being incurred from the small, limited use, fleet of company owned trucks, excessive LTL shipment charges, exceptionally high storage costs, and large In/Out processing fees. The fundamental driver of these costs was the increasing intra-DC shipments of products as management attempted to balance inventories and maintain customer service levels in all 46 facilities. Once a baseline cost was established, simulations were performed to identify the lowest total system cost of the multitude of potential scenarios for points of distribution and shipping providers.

For purposes of the study, costs and locations of existing third-party providers were used to define the least cost network. Although other statistically significant locations may have shown lower costs, the simulations were performed with existing providers to simplify both the simulations and the actual implementation of the proposed network. The proposed network recommended 14 providers already being used by the producer. However, during implementation, the specific list of providers was not as critical as the general location and price range of each warehouse. Final selection of the points of distribution would address specific issues including historical customer service and capacity of each facility.

The recommended distribution network had a potential savings of 26% over the existing plan. Of the identified savings, 69% resulted from consolidation of the points of distribution from 46 to 14. The remaining savings was associated with process changes, supplier relationships, and information technology applications. Table 1 summarizes the relative potential savings.

Consolidation 69%
– Reduced multiple transfers (43%)
– Reduced inventory levels (34%)
– Haulage & Storage (16%
– Reduced outdated product (7%)
   
Warehouse Control System & Order Entry Tech. 14%
Direct shipments to customer 11%
Other 6%

Table 1: Relative Savings From New Distribution Plan

Consolidation

In the rapidly growing market, customer order fulfillment requirements were being met by locating distribution facilities near each major customer. Essentially, the supplier was subsidizing the customer inventory. Centralization of the points of distribution in this situation meant lowering the system wide inventory level and allowing for improved inventory management capability.

Multiple Product Transfers

Along with reducing the overall transportation and storage costs, there was a significant potential cost savings in eliminating multiple product transfers. A multiple product transfer is a move from one point-of-distribution to another after the original product receipt from a production facility. Multiple product transfers are a waste of both time and effort and were the result of doing things right rather than doing the right things. Most of the multiple product transfers were justified as a means to redistribute inventory throughout the network in an attempt to better meet customer demands. Fewer distribution points simplified the inventory management process and reduced the frequency of order expediting. 43% of the consolidation savings was from the elimination of this double handling.

Inventory Reductions

System wide inventory reduction accounted for 34% of the consolidation savings. Fewer points-of-distribution have a direct impact on finished goods safety stock levels. Safety stock calculations were based on maintaining a minimum 95% order fill rate for each facility.

Haulage & Storage

16% of the consolidation savings resulted from a reduction in haulage and storage. With fewer points of distribution, more shipments could be done with more efficient and cost effective TL’s. Additionally, volume discounts and economies of scale could be realized.

Outdated Product

The reduction of outdated (unsaleable) product resulted in 7% of the consolidation savings. Outdated product was a result of ineffective information infrastructure and the human error associated with an un-automated memory based First-in / First-out (FIFO) inventory system.

Warehouse Control System & Order Entry Technology

A batch locator system working in conjunction with an automated order entry system had a significant reduction in labor required to perform daily physical inventories and eliminate the need to redundantly collect order shipment data. In each production facility, shipping and receiving (S&R) personnel were spending roughly three hours per day taking finished goods inventory. Additionally, a monthly raw material inventory is done and takes approximately one 8 hour day to complete. Investing in a basic warehouse control system would result in a 14% labor cost savings.

Direct Shipments

In an effort to maintain product accountability, sub-contracted product was being funneled through distribution centers essentially adding cost with negligible value added. To squeeze costs from this source, consideration was given to direct shipping produce from the sub-contractor to the customer. Achieving a 50% direct ship system would resulted in a 11% cost reduction.

Looking to the Future

There will be fewer, larger, centralized warehouses in the future, replacing the more numerous, smaller, decentralized warehouses of the past. There will be fewer managers and administrative personnel involved with distribution, as integrated distribution is pursued and distribution staffs are centralized. Along with the centralization of warehouses and staffs will come the centralization of order entry, customer service, and data processing. The increased responsiveness of transportation at lower costs, the focus on the total cost of distribution, the realities of customer satisfaction, pace variety and adaptability all point toward centralization. The trend toward centralized distribution will result in higher inventory turnover, which in turn will lead to new opportunities for automation and information technology. As the benefits of these innovations are realized, this will further enforce the trend toward centralization.

Distribution leadership should embrace centralization and proactively plan the future of their integrated, centralized distribution operations. This is contrary to the traditional approach, in which distribution management responds to external circumstances. In today’s distribution environment, distribution leadership must strategically plan for centralization, to allow distribution to become a company’s tool for achieving customer satisfaction.

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