1. Why is it important for a firm to periodically review its logistics network design?

How
do a firms requirements for its logistics network change over time?

The factors that affect the performance of the logistics network are not static, i.e., they change
over time. These factors include demand, product design, various costs in the logistics network,
regulations, contracts, etc. The effects of these dynamics need to be evaluated periodically in
order to determine whether the existing configuration is still satisfactory given the new
operating environment.
For instance, service level requirements may change due to increased competition which
typically means that the lead time to fulfill customer orders needs to be shortened. This may
require the firm to redesign its logistic network and build new warehouses that are closer to the
end customers.
----------------------------2. Within the organization, who is involved in a network design project (operations, sales,
marketing executives, etc.)? How?

The design of the logistics network is a strategic decision that has long lasting effects and
impacts all functions within the company. For the success of such a project, many levels of the
organization must be involved:
1. Upper Management: The new design must be aligned with the vision and strategic goals of
the company. Additionally, such a project may be costly, so management buy-in is essential
to ensure that sufficient resources are devoted to the project.
2. Sales and Marketing: Demand forecasts and anticipated changes in product design and
offerings affect the network and need the involvement of sales and marketing teams.
3. Manufacturing and Operations: The logistics network design has obvious impact on day-today operation of the firm. In order for the implementation to succeed, it is essential that the
people involved with operating the system on a daily basis are involved in its design.
-----------------------------------------------3. KLF Electronics is an American manufacturer of electronic equipment. The company
has a single manufacturing facility in San Jose, California. KLF Electronics distributes its
products through five regional warehouses located in Atlanta, Boston, Chicago, Dallas,
and Los Angeles. In the current distribution system, the United States is partitioned into
five major markets, each of which is served by a single regional warehouse. Customers,
typically retail outlets, receive items directly from the regional warehouse in their market
area. That is, in the current distribution system, each customer is assigned to a single
market and receives deliveries from one regional warehouse. The warehouses receive
items from the manufacturing facility. Typically, it takes about two weeks to satisfy an
order placed by any of the regional warehouses. In recent years, KLF has seen a
significant increase in competition and huge pressure from their customers to improve
service level and reduce costs. To improve service level and reduce costs, KLF would
like to consider an alternative distribution strategy in which the five regional warehouses

are replaced with a single, central warehouse that will be in charge of all customer orders.
Describe how you would design a new logistics network consisting of only a single
warehouse. Provide an outline of such an analysis: What are the main steps? Specifically,
what data would you need? What are the advantages and disadvantages of the newly
suggested distribution strategy relative to the existing distribution strategy?
KLF KLF

2
KLF
KLF

The decision that a single warehouse will be built has been made up-front. Therefore, we only
need to focus on the location and capacity of the warehouse, and determine how much space
should be allocated to each product in the warehouse. The main steps of the analysis are
outlined below.
1. Data collection
i.
Location of retail stores, existing warehouses (5 warehouses located in
Atlanta, Boston, Chicago, Dallas and Los Angeles), manufacturing facilities (a single
manufacturing facility in San Jose), and suppliers.
ii.
Candidate locations for the new warehouse.
iii.
Information about products, i.e., their sizes, shapes and volumes.
iv.
Annual demand (past actuals and future estimates) and service level
requirements of the retail stores.
v.
Transportation rates by available modes.
vi.
Transportation distances from candidate warehouse locations to retail
stores.
vii.
Handling, storage and fixed costs associated with warehousing. Fixed
costs should be expressed as a function of warehouse capacity.
viii.
Fixed ordering costs, order frequencies and sizes by product or product
family.
2. Data aggregation. Demand needs to be aggregated based on distribution patterns and/or
product types. Replace aggregated demand data points by a single customer.
3. Mathematical model building.
4. Model validation based on existing network structure.
5. Selection of a few low cost alternatives based on the mathematical model.
i.
For the final decision, incorporate qualitative factors that were
disregarded in the mathematical model, e.g., specific regulations, environmental
factors, etc.

ii.

Optionally, build a detailed simulation model to evaluate these low cost

candidate solutions.
6. Decide where to locate the centralized warehouse..
With the centralized warehouse, service level will increase (less stock-outs) and inventory
holding costs will decrease due to risk pooling. Also, fixed costs associated with warehousing
will typically decrease, and inbound transportation costs from the manufacturing facility to the
warehouse should be less than the sum of the previous inbound transportation costs. However,
we will incur increased outbound transportation costs from the central warehouse to the
retailers. In summary, the essential design trade-off is between transportation costs on one
hand, and inventory holding costs and service level requirements on the other.
--------------------------------------------------4. In selecting potential warehouse sites, it is important to consider issues such as
geographical and infrastructure conditions, natural resources and labor availability, local
industry and tax regulations, and public interest. For each of the following industries,
give specific examples of how the issues listed above could affect the choice of potential
warehouse sites:
a. Automobile manufacturing
b. Pharmaceuticals
c. Books
d. Aircraft manufacturing
e. Book distribution
f. Furniture manufacturing and distribution
g. PC manufacturing

a.
b.
c.
d.
e.
f.
g.
a.

In automobile manufacturing, cars are usually delivered over land, and demand is concentrated
around major cities. Therefore, we would expect warehouses in this industry to be located near
large cities with easy access to freeways and railroads. This would help to reduce the delivery lead
time to dealerships in the cities.
b.
In the pharmaceutical industry, overnight delivery is common. Therefore, proximity to a major
airport is a factor that should be considered when choosing a warehouse location. Additionally, for
raw material warehouses it is important that these are close to natural resources.
c.
In the book industry, supplier warehouse locations would be affected by the availability of
nearby natural resources.
d.
In the aircraft manufacturing industry, sub-assemblies and parts are delivered by thousands of
suppliers scattered all over the globe to the manufacturing facilities. Therefore, for these supplier

warehouses, by far the most significant consideration is the ability to ship parts easily and on-time,
i.e., the proximity to railroads, freeways, harbors, etc. In such a capital intensive industry, we would
also expect that regulations such as tax breaks have an impact on potential warehouse locations.
e.
With a large customer base shopping for books on-line, short delivery lead times are crucial.
Therefore, in book distribution, we would expect to find large centralized warehouses on
reasonably priced land and where quick transportation modes are available.
f.
Furniture manufacturing and distribution depends heavily on manual labor. Therefore,
warehouses in this industry should be located close to cities with sufficient labor supply.
g.
In PC manufacturing, outsourcing from all around the world is common where labor is cheaper
and regulations favor the huge investments associated with high-tech manufacturing. These
considerations should be factored in when choosing candidate warehouse locations.

--------------------------------------5. Consider the pharmaceutical and the chemical industries. In the pharmaceutical
industry, products have high margins and overnight delivery typically is used. On the
other hand, in the chemical industry, products have low margins and outbound
transportation cost is more expensive than inbound transportation. What is the effect of
these characteristics on the number of warehouses for firms in these industries? Where do
you expect to see more warehouses: in the chemical industry or the pharmaceutical
industry?

In the pharmaceutical industry, we would expect more warehouses closer to the end customers
for short delivery lead times. On the other hand, in the chemical industry there would be fewer
centralized warehouses in order to consolidate orders and decrease outbound transportation
costs.
--------------------------------------------------6. In Section 3.2.3, we observe that the TL transportation rate structure is asymmetric.
Why?
3.2.3 TL
If we expect that the truck would travel empty on its return route, then TL rate would be higher.
Considering the example discussed in the chapter, the probability that the truck comes back empty from
Illinois (industrial heartland) to New York is lower than the corresponding probability from New York
to Illinois which explains the asymmetric cost structure between these two cities.

--------------------------------------------------7. Discuss some specific items that make up the handling costs, fixed costs, and storage
costs associated with a warehouse.

1. Handling Costs
i. Labor cost of workers in material handling.
ii. Cost of conveyors, fork lifts, automated guided vehicles (AGVs), etc., used to carry the
goods in the warehouses. Note that these costs have two components: variable costs

that are linearly proportional to the distances the goods are transported over; and
purchasing costs of equipment that are proportional to the daily output required from
the material handling system, but in a non-linear way because equipment is purchased
in discrete quantities.
2. Fixed Costs
i.
Purchasing or rental cost of land.
ii. Cost of maintaining and operating the warehouse building which includes annual
depreciation and utility costs.
iii.
Cost of racks that depend on the capacity of the warehouse.
iv. The cost of insurance for the facility.
3. Storage Costs
i. Opportunity cost of capital tied up in inventory.
ii. Cost of price declines while inventory is sitting in the warehouse. Note that this
includes the risk of obsolete inventory that needs to be salvaged.
-----------------------------------8. What is the difference between using an exact optimization technique and a heuristic to
solve a problem?

An exact optimization technique is guaranteed to provide an optimal solution (if one exists)
even if it takes a long time. On the other hand, a heuristic algorithm is a method that will find
good solutions to the problem in a reasonable amount of time where the terms good and
reasonable depend on the heuristic and the particular problem instance. The choice between
an exact optimization technique and a heuristic algorithm for a given problem frequently
depends on the trade-off between solution quality and solution time. Note that even if a
heuristic algorithm (by chance) finds the optimal solution to a problem, it cannot confirm the
optimality of the solution. On the other hand, for many problems there are no known optimal
algorithms, so heuristics must be used.
-----------------------------------------------9. What is simulation, and how does it help solve difficult logistics problems?

Simulation is a popular performance evaluation and modeling tool for complex stochastic
systems that cannot be evaluated analytically. A simulation model can closely reflect a real
system and mimic its behavior, but it has some drawbacks: simulation is a descriptive tool,
i.e., it cannot provide optimal values for system inputs. It generates, for a given set of inputs,
sample outputs from the system that are used to compute statistical estimates of the
performance measures. Also, accurate simulation models of large systems require extensive
development effort, and typically take a long time to run. Thus, we advocate a two-phase
approach to solve difficult logistics problems:
1.

Use a mathematical optimization model to generate a number of good candidate

solutions, taking into account the most important cost components.

2.

Use a detailed simulation model to evaluate the candidate solutions generated in the
first phase.