Value-Chain Report -- Optimizing Supply-Chain Networks

Dec. 21, 2004
Optimization tools, while increasingly robust and sophisticated, are only as good as the underlying data and assumptions.

Other than those established very recently by dot-com start-ups, most supply chains have evolved as a result of opportunistic business conditions rather than via an optimization strategy. Access to transportation, labor costs, temporary tax incentives and myriad other factors often determine production and/or distribution facility locations. However, over the last decade, increasingly sophisticated analytical tools from leading supply-chain solution providers, such as i2 Technologies and Manugistics, have emerged to help companies address optimization of their supply-chain networks. These tools allow companies to model existing and alternative supply-chain networks and identify the trade-offs in cost, service and time that must be made in developing a supply-chain strategy that optimizes competitive position depending on the characteristics of the particular industry. Network Optimization: From Simple to Complex The simplest supply chain addressed by optimization is the distribution network. This type of network is characterized by a flow of finished products between origins and destinations. Origins are facilities that originate freight, typically factory warehouses or distribution centers. Destinations are facilities that receive freight, mainly customer locations. The network could, however, represent an origin of supplier facilities or manufacturing plants and a destination of distribution centers. Simple network optimization typically involves direct shipments from origins to destinations. The analysis can easily be extended to cover multi-tier distribution systems. In this case, intermediate-level network facilities are introduced between origins and destinations for cost or service considerations. The advantages that may be gained through multi-tier networks typically include lower overall transportation costs and improved response times. However, potential disadvantages may include increased inventory and facility costs. A more advanced type of network that can be addressed via optimization involves the broader logistics environment. Optimization for this type of network may involve simultaneously determining the number, location and mission of production facilities, supplier locations, as well as the previously described distribution network. The most complex type of network that can be addressed via optimization is the multi-national supply chain. Optimization for this type of network is likely to involve simultaneously determining the best ports for loading and unloading and the best customs points at which to cross borders, as well as the number, location and mission of suppliers, manufacturing plants and distribution facilities across the globe. Other considerations in optimizing an international supply chain network typically include tariffs and taxes, import and export duties, duty drawbacks, transfer prices and local content rules. In order to provide an optimized solution for the supply-chain network -- one that provides the desired operating performance and the lowest cost -- analytical tools must be supported by a thorough understanding of the business needs to be addressed by the supply chain. These business needs include:

  • Customers and Markets
  • Logistics
  • Production
  • Sourcing and Procurement
  • Network Infrastructure Customers and Markets Customer/market requirements and the competitive environment that the supply-chain network is addressing must be well defined. These issues are likely to include:
    • How well defined/understood are current markets, channels and customers?
    • How well are the service requirements understood/measured for different channels or customers?
    • How significant are the changes in projected demand for each market, channel and customers?
    Optimization of the supply-chain network must address customer-service requirements (e.g., response times, fill rates, order completeness). If these requirements cannot be clearly identified, it will be nearly impossible to design an optimized supply-chain network. Logistics Supply-chain network optimization considers an overall flow of products through a facility over a specific period of time. Therefore, network optimization tools typically do not consider facility layout or space requirements, other than capacity and cost estimates used to reflect actual physical conditions. However, outputs from a network optimization tool can assist in estimating space requirements for a distribution facility, based on known storage space/throughput/inventory level relationships. Most network optimization tools estimate inventory levels required to support demand, based on throughput required for a period of time and historical inventory level/throughput relationships. Network optimization tools will typically factor storage and inventory carrying costs for the calculated inventory levels into the optimal solution. Production For optimization of more complex supply-chain networks, additional consideration must be given to sources of supply. For products manufactured internally, factors related to production need to be evaluated, such as:
    • How well defined are individual manufacturing costs by product or by location?
    • Can plant fixed costs and individual production line fixed costs be easily separated from variable unit production costs?
    • How significant are production capacity constraints? How are minimum and maximum capacities measured?
    • How well defined are any future manufacturing processes/costs/capacities?
    Manufacturing is captured within network optimization tools by modeling the major processes utilized for producing selected products. Analysis is based on the relative costs for producing at given facilities and available capacities. The robustness of the solution depends upon how accurately true production costs for products can be allocated in this manner, as well as the proportion of total supply-chain costs that manufacturing represents. Sourcing and Procurement Supplier locations, costs and capacities can have a significant impact on the performance of a supply-chain network. Factors likely to influence optimization of the network would include:
    • How significant are supplier constraints (e.g., capacity, capability)?
    • How well defined are supplier costs (material costs and inbound freight costs)?
    • How well defined are any future supplier scenarios (e.g., consolidation of existing suppliers, current manufacturing processes pushed back onto supplier)?
    Network Infrastructure Involvement of multiple business units and/or organizations, or the inclusion of third-party facilities in the supply-chain-network optimization process, often adds to the time and effort required to complete the analysis. It is important to understand:
    • Does the supply-chain network involve multiple business units or organizations?
    • How significant are third parties in the network (e.g., packaging or warehousing)?
    • Are there new facilities being proposed? How well defined are their costs, capacities, etc.?
    Regarding supply-chain network facilities, network optimization tools typically recommend only a facility's general location, not a specific building or site. Site selection should consider local demographic, socio-economic, employment, real estate and environmental factors in identifying suitable locations within the targeted area. In addition, local incentives and state/local tax minimization must be considered. Optimization analysis for a company's supply-chain network can have fundamental and significant effects on the overall performance of the business and organization. However, optimization tools, while increasingly robust and sophisticated, are only as good as the underlying data and assumptions. Successful application of supply-chain network optimization tools depends on the accuracy of the information used in analysis and the skills of the team charged with formulating the strategy recommendations. Kevin P. O'Brien is a Cap Gemini Ernst & Young practice leader for supply-chain consulting with high-growth and middle-market companies. David T. Ford is a Cap Gemini Ernst & Young solution leader for supply-chain network design and supply-chain strategy consulting.
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