Management of

Business Logistics
Dr. LE THI DIEM CHAU
Dr. TRAN QUYNH LE
Dr. Nguyen Tien Dung
Assoc. Prof. Dr. Le Ngoc Quynh Lam
Industrial Systems Engineering Department
Mechanical Engineering Faculty
Ho Chi Minh City University of Technology (HCMUT)–VNUHCM
CHAPTER 9:Logistics Network Configuration

2
 Learning Objective

• How a company can develop a model representing its logistics network.

• How a company can validate this model.

• How aggregating customers and products affects the accuracy of the model.

• How a company know how many distribution centers to establish.

• How a company knows where to locate these DCs.

• How a company allocates the output of each product in its plants among its DCs.

• How a company knows whether, when and where to expand its production capacity.

3
 The Logistics Network

▪ The Logistics Network consists of:

✓ Facilities: Vendors, Manufacturing Centers, Warehouse/ Distribution Centers, Retail

outlets and Customers

✓ Raw materials, work in process inventory and finished products that flow between
the facilities.

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 Decision Classifications

▪ Strategic Planning: Decisions that typically involve major capital investments and
have a long term effect:

1. Determination of the number, location and size of new plants, distribution centers
and warehouses

2. Acquisition of new production equipment and the design of working centers

within each plant

3. Design of transportation facilities, communications equipment, data processing

means, etc

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Decision Classifications

◼ Tactical Planning: Effective allocation of manufacturing and distribution

resources over a period of several months

1. Work-force size

2. Inventory policies

3. Definition of the distribution channels

4. Selection of transportation and trans-shipment alternatives

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Decision Classifications

◼ Operational Control: Includes day-to-day operational decisions

1. The assignment of customer orders to individual machines

2. Dispatching, expediting and processing orders

3. Vehicle scheduling

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Network Design: Key Issues

◼ Pick the optimal number, location, and size of warehouses and/or plants

◼ Determine optimal sourcing strategy

❑ Which plant/vendor should produce which product

◼ Determine best distribution channels

❑ Which warehouses should service which customers

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Network Design: Key Issues

The objective is to balance service level against

◼ Production/ purchasing costs

◼ Inventory carrying costs

◼ Facility costs (handling and fixed costs)

◼ Transportation costs

That is, we would like to find a minimal-annual-cost configuration of the distribution

network that satisfies product demands at specified customer service levels.

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Network Design Tools: Major Components

◼ Mapping
❑ Mapping allows you to visualize your supply chain and solutions
❑ Mapping the solutions allows you to better understand different scenarios
❑ Color coding, sizing, and utilization indicators allow for further analysis
◼ Data
❑ Data specifies the costs of your supply chain
❑ The baseline cost data should match your accounting data
❑ The output data allows you to quantify changes to the supply chain
◼ Engine
❑ Optimization Techniques

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Mapping Allows You to Visualize Your Supply Chain

13
Displaying the Solutions Allows you To Compare Scenarios
Data for Network Design

1. A listing of all products

2. Location of customers, stocking points and sources
3. Demand for each product by customer location
4. Transportation rates
5. Warehousing costs
6. Shipment sizes by product
7. Order patterns by frequency, size, season, content
8. Order processing costs
9. Customer service goals

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Too Much Information

Customers and Geocoding

◼ Sales data is typically collected on a by-customer basis

◼ Network planning is facilitated if sales data is in a geographic database rather

than accounting database
1. Distances
2. Transportation costs

◼ New technology exists for Geocoding the data based on Geographic Information
System (GIS)

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Data Collection
◼ Location of customers, retailers, existing warehouses and DCs, manufacturing
facilities, and suppliers.
◼ All products, including volumes, and special transport modes. (e.g. frozen food
need freezer)
◼ Annual demand for each product by customer location.
◼ Transportation rate by mode.
◼ Warehousing costs, including labor, inventory carrying charges, and fixed
operating costs.
◼ Shipment sizes and frequencies for customer delivery.
◼ Order processing costs.
◼ Customer service requirements and goals.
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Data aggregation

◼ Customer location aggregation using a grid network or clustering technique.

◼ Item aggregation based on

❑ Distribution pattern

❑ Product type

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Aggregating Customers

◼ Customers located in close proximity are aggregated using a grid network or

clustering techniques.

◼ All customers within a single cell or a single cluster are replaced by a single
customer located at the centroid of the cell or cluster.

◼ We refer to a cell or a cluster as a customer zone.

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Impact of Aggregating Customers

◼ The customer zone balances

1. Loss of accuracy due to over aggregation

2. Needless complexity

◼ What effects the efficiency of the aggregation?

1. The number of aggregated points, that is the number of different zones

2. The distribution of customers in each zone.

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Why Aggregate?

◼ The cost of obtaining and processing data

◼ The form in which data is available

◼ The size of the resulting location model

◼ The accuracy of forecast demand

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Recommended Approach

Use at least 200 aggregated points

Make sure each zone has an equal

amount of total demand

Place the aggregated point at the

center of the zone

In this case, the error is typically no

more than 1%

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Recommended Approach

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Factors Affect the Transportation Cost
◼ Density of Product = weight / volume
◼ Stowability=ability to pack in the vehicle
◼ Ease of Handling
◼ Perishability
◼ Packaging
◼ Liability = insurance of products from loss, damage, etc.

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Factors affect the Transportation cost and Price Quotation

◼ Competition within the same mode of transportation and between the mode
◼ Location of demand
◼ Law and Regulation
◼ Equality of Inbound and Outbound
◼ Seasonality
◼ Domestic and International transportation cost are different and depend on
quotation

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Type of Road Transportation

◼ Truckload: TL
◼ Less Than Truckload: LTL

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Warehouse Costs

◼ Handling costs
❑ Labor and utility costs
❑ Proportional to annual flow through the warehouse.
◼ Fixed costs
❑ All cost components not proportional to the amount of flow
❑ Typically proportional to warehouse size (capacity) but in a nonlinear way.
◼ Storage costs
❑ Inventory holding costs
❑ Proportional to average positive inventory levels.

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 Determining Fixed Costs
FIGURE 3-8: Warehouse fixed costs as a function of the warehouse capacity

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Determining Storage Costs

◼ Multiply inventory turnover by holding cost

◼ Inventory Turnover =

Annual Sales / Average Inventory Level

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Warehouse Capacity

◼ Estimation of actual space required

◼ Average inventory level =
Annual flow through warehouse/Inventory
turnover ratio
◼ Space requirement for item = 2Average
Inventory Level
◼ Multiply by factor to account for
❑ access and handling

❑ aisles,

❑ picking, sorting and processing facilities

❑ AGVs

◼ Typical factor value = 3

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Warehouse Capacity Example

◼ Annual flow = 1,000 units

◼ Inventory turnover ratio = 10.0
◼ Average inventory level = 100 units
◼ Assume each unit takes 10 sqft. of space
◼ Required space for products = 2,000 sqft.
◼ Total space required for the warehouse is about 6,000 square feet

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Important factors to choose the best size for a warehouse

◼ The number of products using the warehouse.

◼ The type of demand for each product, how much it varies, average order size.
◼ Physical features of the products, particularly size and weight.
◼ Special storage conditions, such as climate control, packaging.
◼ Target customer service level.
◼ Lead times from suppliers and promised to customers.
◼ Economies of scale.
◼ Type of material handling equipment.
◼ Layout of storage and related facilities.

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Potential Locations

◼ Geographical and infrastructure conditions.

◼ Natural resources and labor availability.
◼ Local industry and tax regulations.
◼ Public interest.

Not many will qualify based on all the above conditions

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 Service Level Requirements

◼ Specify a maximum distance between each customer and the warehouse

serving it
◼ Proportion of customers whose distance to their assigned warehouse is no
more than a given distance
❑ 95% of customers be situated within 200 miles of the warehouses serving

them
❑ Appropriate for rural or isolated areas

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Future Demand

◼ Strategic decisions have to be valid for 3-5 years

◼ Consider scenario approach and net present values to factor in expected future
demand over planning horizon

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Minimize the cost of your logistics network
without compromising service levels

$90 Optimal
$80
Number
of Warehouses
$70
Cost (millions $)

$60
Total Cost
$50 Transportation Cost
$40 Fixed Cost
Inventory Cost
$30

$20

$10

$-

0 2 4 6 8 10
Number of Warehouses 36
The Impact of Increasing the Number of Warehouses
◼ Improve service level due to reduction of average service time to customers.

◼ Increase inventory costs due to a larger safety stock.

◼ Increase overhead and set-up costs.

◼ Reduce transportation costs in a certain range

❑ Reduce outbound transportation costs

❑ Increase inbound transportation costs

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Industry Benchmarks: Number of Distribution Centers

Pharmaceuticals Food Companies Chemicals

Avg.
# of
WH 3 14 25
- High margin product
- Service not important (or - Low margin product
easy to ship express) - Service very important
- Inventory expensive - Outbound transportation
relative to transportation expensive relative to inbound

Sources: CLM 1999, Herbert W. Davis & Co; LogicTools

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A Typical Network Design Model
◼ Several products are produced at several plants.
◼ Each plant has a known production capacity.
◼ There is a known demand for each product at each customer zone.
◼ The demand is satisfied by shipping the products via regional
distribution centers.
◼ There may be an upper bound on total throughput at each distribution
center.

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A Typical Location Model

• There may be an upper bound on the distance between a distribution

center and a market area served by it.

• A set of potential location sites for the new facilities was identified

• Costs:

• Set-up costs

• Transportation cost is proportional to the distance

• Storage and handling costs

• Production/supply costs

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Complexity of Network Design Problems

◼ Location problems are, in general, very difficult problems.

◼ The complexity increases with

❑ the number of customers,
❑ the number of products,
❑ the number of potential locations for warehouses, and
❑ the number of warehouses located.

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Solution Techniques
◼ Mathematical optimization techniques:

1. Exact algorithms: find optimal solutions

2. Heuristics: find “good” solutions, not necessarily optimal

◼ Simulation models: provide a mechanism to evaluate specified

design alternatives created by the designer.

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Heuristics and the Need for Exact Algorithms

◼ Single product
◼ Two plants p1 and p2
❑ Plant P1 has an annual capacity of 200,000 units.
❑ Plant p2 has an annual capacity of 60,000 units.
◼ The two plants have the same production costs.
◼ There are two warehouses w1 and w2 with identical warehouse handling costs.
◼ There are three markets areas c1,c2 and c3 with demands of 50,000, 100,000
and 50,000, respectively.

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 Why Optimization Matters?
Table 1 Distribution costs per unit

Facility P1 P2 C1 C2 C3
Warehouse
W1 0 4 3 4 5
W2 5 2 2 1 2

$0
$3 D = 50,000
Cap = 200,000
$4

$5
$5 D = 100,000
$4 $2

$2 $1
Cap = 60,000
$2
D = 50,000

Production costs are the same, warehousing costs are the same

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Traditional Approach #1:
Assign each market to closet WH. Then assign each plant based on
cost.

D = 50,000
Cap = 200,000

$5 x 140,000 D = 100,000
$2 x 50,000

$2 x 60,000 $1 x 100,000
Cap = 60,000
$2 x 50,000
D = 50,000

Total Costs = $1,120,000

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 Traditional Approach #2:
Assign each market based on total
landed cost
D = 50,000
P1 to WH1 $3
P1 to WH2 $7
$0 P2 to WH1 $7
$3 P2 to WH 2 $4
Cap = 200,000
$4
D = 100,000
$5
$5 P1 to WH1 $4
P1 to WH2 $6
$4 $2 P2 to WH1 $8
$1 P2 to WH 2 $3
$2
Cap = 60,000
$2
D = 50,000
P1 to WH1 $5
P1 to WH2 $7
P2 to WH1 $9
P2 to WH 2 $4

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 Traditional Approach #2:
Assign each market based on total
landed cost

D = 50,000
P1 to WH1 $3
$0 P1 to WH2 $7
$3 P2 to WH1 $7
Cap = 200,000 P2 to WH 2 $4
$4

$5 D = 100,000
$5
P1 to WH1 $4
$4 $2 P1 to WH2$6
P2 to WH1 $8
$2 $1
P2 to WH 2$3
Cap = 60,000
$2
D = 50,000
P1 to WH1 $5
P1 to WH2 $7
P2 to WH1 $9
P2 to WH 2 $4

Market #1 is served by WH1, Markets 2 and 3 are served by WH2

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 Traditional Approach #2:
Assign each market based on total
landed cost

D = 50,000
P1 to WH1 $3
P1 to WH2 $7
$0 x 50,000
P2 to WH1 $7
$3 x 50,000
P2 to WH 2 $4
Cap = 200,000
D = 100,000
$5 x 90,000 P1 to WH1 $4
P1 to WH2 $6
$1 x 100,000 P2 to WH1 $8
$2 x 60,000 P2 to WH 2 $3
Cap = 60,000
$2 x 50,000
D = 50,000
P1 to WH1 $5
P1 to WH2 $7
P2 to WH1 $9
P2 to WH 2 $4
Total Cost = $920,000

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The Optimization Model

◼ The problem described earlier can be framed as the following linear programming
problem.

Let
◼ x(p1,w1), x(p1,w2), x(p2,w1) and x(p2,w2) be the flows from the plants to the
warehouses.

◼ x(w1,c1), x(w1,c2), x(w1,c3) be the flows from the warehouse w1 to customer zones
c1, c2 and c3.

◼ x(w2,c1), x(w2,c2), x(w2,c3) be the flows from warehouse w2 to customer zones c1,
c2 and c3

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The Optimization Model

The problem we want to solve is:

min 0x(p1,w1) + 5x(p1,w2) + 4x(p2,w1)
+ 2x(p2,w2) + 3x(w1,c1) + 4x(w1,c2)
+ 5x(w1,c3) + 2x(w2,c1) + 2x(w2,c3)
Subject to the following constraints:
x(p2,w1) + x(p2,w2) 60000
x(p1,w1) + x(p2,w1) = x(w1,c1) + x(w1,c2) + x(w1,c3)
x(p1,w2) + x(p2,w2) = x(w2,c1) + x(w2,c2) + x(w2,c3) x(w1,c1) + x(w2,c1) =
50000
x(w1,c2) + x(w2,c2) = 100000 x(w1,c3) + x(w2,c3) = 50000
all flows greater than or equal to zero.

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 The Optimal Strategy

Table 2 Distribution strategy

Facility P1 P2 C1 C2 C3
Warehouse

W1 140000 0 50000 40000 50000

W2 0 60000 0 60000 0

The total cost for the optimal strategy is 740,000.

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Designing the Logistics Network

Single-Echelon Single-Commodity
Location Models (SESC)

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Designing the Logistics Network

Single-Echelon Single-Commodity Location Models (SESC)

Assumption
1. Homogeneous (one-type) facility and flow.

2. Material flow into or flow out of the facilities is negligible (next page)

3. Transportation cost is linear or piecewise linear.

4. Facility operating cost is linear or piecewise linear.

5. Demand is divisible.

56
Designing the Logistics Network

57
Designing the Logistics Network

SESC Model
• Defined on a “Bipartite complete directed graph” G(V1 U V2, A)
• V1 = a set of potential facilities.
• V2 = a set of the customer locations with demand to satisfy.
• A = V1 x V2 = a set of arc to represent the material flow between
facilities and customer.

Parameter and Decision variables notation

• i = facility index, i  V1
• j = customer index, j  V2
• dj = demand of customer j
• qi = capacity of the potential facility I

• ui = operations in potential facility i (decision variable)

• sij = amount of product transported from i to j (decision variable)

• Fi(ui) = cost of operating facility i

• Cij(sij) = cost of transporting sij units of products from i to j

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Designing the Logistics Network

59
Designing the Logistics Network

The meaning of mathematical formulation

• ui → indicate that facility i is open or not.
• sij → indicate the allocation of customer j to facility i.

• Obj func (3.1): sum of the facility operating costs and the
transportation cost.

• Con (3.2): sum of the flow from one facility to every customer equal
the activity level.

• Con (3.3): sum of the flow into one customer equal the customer
demand.

• Con (3.4): activity level at any facility must not exceed the capacity.

60
Distribution Strategies
Introduction
◼ Focus on the distribution function.
◼ Various possible distribution strategies, and the opportunities and challenges associated
with these strategies.
◼ Two fundamental distribution strategies:
❑ Items can be directly shipped from the supplier or manufacturer to the retail stores or
end customer
❑ Use intermediate inventory storage points (typically warehouses and/or distribution
centers).
◼ Issues with warehouses
❑ Manufacturing strategy (make-to-stock vs. make-to-order)

❑ Number of warehouses

❑ Inventory policy

❑ Inventory turn over ratio

❑ Internal warehouses vs. outside distributor

❑ Owned by a single firm or by a variety of firms

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Direct Shipment Distribution Strategies

◼ Advantages:
❑ The retailer avoids the expenses of operating a distribution center
❑ Lead times are reduced.
◼ Disadvantages:
❑ Risk-pooling effects are negated
❑ Manufacturer and distributor transportation costs increase
◼ Commonly used scenarios:
❑ Retail store requires fully loaded trucks
❑ Often mandated by powerful retailers
❑ Lead time is critical.
❑ Manufacturer may be reluctant but may have no choice
❑ Prevalent in the grocery industry
◼ lead times are critical because of perishable goods.

63
Intermediate Inventory Storage Point Strategies

◼ Variety of characteristics distinguish different strategies.

❑ Length of time inventory is stored at warehouses and distribution centers.

◼ Strategies:
❑ Traditional warehousing strategy

◼ distribution centers and warehouses hold stock inventory

◼ provide their downstream customers with inventory as needed.

❑ Cross-docking strategy
◼ warehouses and distribution centers serve as transfer points for inventory

◼ no inventory is held at these transfer points.

❑ Centralized pooling and transshipment strategies
◼ may be useful when there is a large variety of different products

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Traditional Warehousing

◼ Inventory management and risk pooling key factors

◼ Other factors also play a significant role
❑ Centralized vs Decentralized Management
❑ Central vs Local Facilities

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Decentralized Management

❑ Each facility identifies its most effective strategy without considering the impact
on the other facilities in the supply chain.
❑ Leads to local optimization.

66
Centralized Management

❑ Decisions are made at a central location for the entire supply network.
❑ Typical objective: minimize the total cost of the system subject to satisfying some
service-level requirements.
❑ Centralized control leads to global optimization.
❑ At least as effective as the decentralized system.
❑ Allow use of coordinated strategies

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If system cannot be centralized

Often helpful to form partnerships to approach the advantages of a centralized

system.

68
Centralized facilities

❑ Employ both fewer warehouses and distribution centers

❑ Facilities are located further from customers.

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Factors of Central vs. Local Facilities

❑ Safety stock. Lower safety stock levels with centralized facilities

❑ Overhead. Lower total overhead cost with centralized facilities
❑ Economies of scale. Greater economies of scale with centralized facilities
❑ Lead time. Lead time to market reduced with local facilities
❑ Service.
◼ Utilization of risk pooling better with centralized

◼ Shipping times better with local

❑ Transportation costs.
◼ Costs between production facilities and warehouses higher with local

◼ Costs from warehouses to retailers lesser with local

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A Hybrid Decision

◼ Some products use centralized strategy while others use local strategy
◼ Not an either or decision
◼ Varying degrees of centralization and localization due to the varying levels of
advantages and disadvantages

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Cross-Docking

◼ Popularized by Wal-Mart
◼ Warehouses function as inventory coordination points rather than as inventory
storage points.
◼ Goods arriving at warehouses from the manufacturer:
❑ are transferred to vehicles serving the retailers
❑ are delivered to the retailers as rapidly as possible.
◼ Goods spend very little time in storage at the warehouse
❑ Often less than 12 hours
❑ Limits inventory costs and decreases lead times

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Issues with Cross-Docking

◼ Require a significant start-up investment and are very difficult to manage

◼ Supply chain partners must be linked with advanced information systems for
coordination
◼ A fast and responsive transportation system is necessary
◼ Forecasts are critical, necessitating the sharing of information.
◼ Effective only for large distribution systems
❑ Sufficient volume every day to allow shipments of fully loaded trucks from the
suppliers to the warehouses.
❑ Sufficient demand at retail outlets to receive full truckload quantities

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Cross-docking
Departing Departing Receiving

Separate
categories
warehouse
Storage
area

warehouse

Receiving

A. First form B. Second form

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 Cross Docking
◼ In 1979, Kmart was the king of the retail industry with 1891
stores and average revenues per store of $7.25 million.

◼ At that time Wal-Mart was a small niche retailer in the

South with only 229 stores and average revenues about
half of those Kmart stores.

◼ Ten years later, Wal-Mart transformed itself; it has the

highest sales per square foot, inventory turnover and
operating profit of any discount retailer.

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What accounts for Wal-Mart’s
remarkable success
◼ The starting point was a relentless focus on
satisfying customer needs; Wal-Mart goal
was simply to provide customers access to
goods when and where they want them and
to develop cost structures that enable
competitive pricing.

◼ The key to achieve this goal was to make the

way the company replenishes inventory.

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What accounts for Wal-Mart’s remarkable success?

◼ This was obtained by using a logistics technique known as cross-docking.

◼ Here goods are continuously delivered to Wal-Mart’s warehouses where they

are dispatched to stores without ever sitting in inventory.
◼ This strategy reduced Wal-Mart’s cost of
sales significantly and made it possible to offer everyday low prices to their
customers

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Distribution Strategies

Strategy Direct Cross Inventory at

Attribute Shipment Docking Warehouses
Risk Take
Pooling Advantage
Transportation Reduced Reduced
Costs Inbound Costs Inbound Costs
Holding No Warehouse No Holding
Costs Costs Costs
Demand Delayed Delayed
Variability Allocation Allocation

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Supply Chain Integration - Dealing with Conflicting Goals

◼ Lot Size vs. Inventory

◼ Inventory vs. Transportation

◼ Lead Time vs. Transportation

◼ Product Variety vs. Inventory

◼ Cost vs. Customer Service

79
Transshipment

Transshipments

Mfg. Distributor
Retailers

80
Transshipment

◼ The shipment of items between different facilities at the same level in the supply
chain to meet some immediate need.

◼ Most consider the transshipment at the retail level.

◼ The transshipment capability allows the retailer to meet customer demand from
the inventory of other retailers.

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 End of Chapter 9

Logistics Network Configuration