Distribution Networks in Supply

Chain

- Dr. Akshay Joshi

Distribution Network Design in the Supply Chain

• Distribution – the steps taken to move and store a

product from the supplier stage to the customer
stage in a supply chain
• Drives profitability by directly affecting supply chain
cost and the customer value
• Choice of distribution network can achieve supply
chain objectives from low cost to high responsiveness
 Role of Distribution Network
• The process of designing a distribution network has
two broad phases.
• In the first phase, the broad structure of the supply
chain network is visualized.
• This phase decides the number of stages in the
supply chain and the role of each stage.
• The second phase then takes the broad structure and
converts it into specific locations and their capability,
capacity, and demand allocation.
 Role of Distribution Network
• The appropriate distribution network can be used to
achieve a variety of supply chain objectives ranging
from low cost to high responsiveness.
• As a result, companies in the same industry often
select different distribution networks.
 Illustration
• Until 2007, Dell distributed its PCs directly to end
consumers, whereas companies such as HP
distributed through resellers.
• Dell customers waited several days to get a PC,
whereas customers could walk away with an HP
computer from a reseller.
• Starting in June 2007, Dell also started selling its PCs
through retailers such as Walmart.
 Illustration
• In the late 1990s, Gateway opened Gateway Country
stores, wherein customers could examine the
products and have salespeople help them configure a
PC that suited their needs.
• Gateway, however, chose to sell no products at the
stores; all PCs were shipped directly from the factory
to the customer.
• By April 2004, Gateway had closed all its stores
because of their poor financial performance.
 Illustration
• Apple Computer, in contrast, has opened many retail
stores that sell computers.
• These companies have chosen different distribution
models.
• P&G has chosen to distribute directly to large
supermarket chains while obligating smaller players
to buy P&G products from distributors.
• Products move directly from P&G to the larger chains
but move through an additional stage when going to
smaller supermarkets.
Factors Affecting Distribution Network Design

• Distribution network performance evaluated along

two dimensions
1. Value provided to the customer
2. Cost of meeting customer needs

• Evaluate the impact on customer service and cost for

different distribution network options
• Profitability of the delivery network determined by
revenue from met customer needs and network costs
Factors Affecting Distribution Network Design
• Elements of customer service influenced by network
structure:
– Response time
– Product variety
– Product availability
– Customer experience
– Time to market
– Order visibility
– Returnability
 Factors Affecting Distribution Network Design
• Response time is the amount of time it takes for a
customer to receive an order.
• Product variety is the number of different products
or configurations that are offered by the distribution
network.
• Product availability is the probability of having a
product in stock when a customer order arrives.
• Customer experience includes the ease with which
customers can place and receive orders and the
extent to which this experience is customized.
 Factors Affecting Distribution Network Design
• It also includes purely experiential aspects, such as
the possibility of getting a cup of coffee and the
value that the sales staff provides.
• Time to market is the time it takes to bring a new
product to the market.
• Order visibility is the ability of customers to track
their orders from placement to delivery.
• Returnability is the ease with which a customer can
return unsatisfactory merchandise and the ability of
the network to handle such returns.
Factors Affecting Distribution Network Design

• Supply chain costs affected by network structure:

– Inventories
– Transportation
– Facilities
– Information
• The other two drivers, sourcing and pricing, also
affect the choice of the distribution system
Desired Response Time and Number of Facilities

Relationship Between Desired Response Time and Number of Facilities

Desired Response Time and Number of Facilities

• Firms that target customers who can tolerate a long

response time require only a few locations that may
be far from the customer.
• These companies can focus on increasing the
capacity of each location.
• In contrast, firms that target customers who value
short response times need to locate facilities close to
them.
• These firms must have many facilities, each with a
low capacity.
Inventory Costs and Number of Facilities

Relationship Between Number of Facilities and Inventory Costs

 Inventory Costs and Number of Facilities

• As the number of facilities in a supply chain increases,

the required inventory increases.
• To decrease inventory costs, firms try to consolidate and
limit the number of facilities in their supply chain
network.
• Inbound transportation costs are the costs incurred
in bringing material into a facility.
• Outbound transportation costs are the costs of
sending material out of a facility.
• Outbound transportation costs per unit tend to be
higher than inbound costs because inbound lot sizes
are typically larger.
 Inventory Costs and Number of Facilities
• For example, an Amazon warehouse receives full
truckload shipments of books on the inbound side,
but ships out small packages with only a few books
per customer on the out- bound side.
• Increasing the number of warehouse locations
decreases the average outbound distance to the
customer and makes outbound transportation
distance a smaller fraction of the total distance
traveled by the product.
Transportation Costs and Number of Facilities

Relationship Between Number of Facilities and Transportation Cost

 Transportation Costs and Number of Facilities
• As long as inbound transportation economies of
scale are maintained, increasing the number of
facilities decreases total transportation cost.
• If the number of facilities is increased to a point at
which inbound lot sizes are also very small and result
in a significant loss of economies of scale in inbound
transportation, increasing the number of facilities
increases total transportation cost.
Facility Costs and Number of Facilities

Relationship Between Number of Facilities and Facility Costs

 Facility Costs and Number of Facilities
• Facility costs decrease as the number of facilities is
reduced, because a consolidation of facilities allows a
firm to exploit economies of scale.

• Total logistics costs are the sum of inventory,

transportation, and facility costs for a supply chain
network.
• As the number of facilities increases, total logistics
costs first decrease and then increase.
Logistics Cost, Response Time, and Number of
Facilities

Variation in Logistics Cost and Response Time with Number of Facilities

 Logistics Cost, Response Time, and Number of
Facilities
• Each firm should have at least the number of
facilities that minimizes total logistics costs.
• If a firm wants to reduce the response time to its
customers further, it may have to increase the
number of facilities beyond the point that minimizes
logistics costs.
• A firm should add facilities beyond the cost-
minimizing point only if managers are confident that
the increase in revenues because of better
responsiveness will be greater than the increase in
costs because of the additional facilities.
 To Sumup
•A manager must consider the customer needs to be
met and the cost of meeting these needs when
designing the distribution network.
• Some key customer needs to be considered include
response time, product variety/availability,
convenience, order visibility, and returnability.
• Important costs that managers must consider include
inventory, transportation, facilities and handling, and
information.
•Increasing the number of facilities decreases the
response time and transportation cost but increases
inventory and facility cost.
 Design Options for a Distribution Network

• Distribution network choices from the manufacturer

to the end consumer
• Two key decisions

1. Will product be delivered to the customer location

or picked up from a prearranged site?
2. Will product flow through an intermediary (or
intermediate location)?
 Design Options for a Distribution Network

• One of six designs may be used

1. Manufacturer storage with direct shipping
2. Manufacturer storage with direct shipping and in-
transit merge
3. Distributor storage with carrier delivery
4. Distributor storage with last-mile delivery
5. Manufacturer/distributor storage with customer
pickup
6. Retail storage with customer pickup
Manufacturer Storage with Direct Shipping
 Manufacturer Storage with Direct Shipping
• In this option, product is shipped directly from the
manufacturer to the end customer, bypassing the retailer
(who takes the order and initiates the delivery request).
• This option is also referred to as drop-shipping.
• The retailer carries no inventory.
• Information flows from the customer, via the retailer, to
the manufacturer, and product is shipped directly from
the manufacturer to customers,
• The biggest advantage of drop-shipping is the ability to
centralize inventories at the manufacturer, which can
aggregate demand across all retailers that it supplies.
 Manufacturer Storage with Direct Shipping
• As a result, the supply chain is able to provide a high
level of product availability with lower levels of
inventory.
• A key issue with regard to drop-shipping is the
ownership structure of the inventory at the
manufacturer.
• If specified portions of inventory at the manufacturer
are allocated to individual retailers, there is little
benefit of aggregation even though the inventory is
physically aggregated.
 Manufacturer Storage with Direct Shipping
• Benefit of aggregation is achieved only if the
manufacturer can allocate at least a portion of the
available inventory across retailers on an as-needed
basis.
• The benefits from centralization are highest for high-
value, low-demand items with unpredictable
demand.
• Drop-shipping also offers the manufacturer the
opportunity to postpone customization until after a
customer has placed an order.
 Manufacturer Storage with Direct Shipping
• Postponement, if implemented, further lowers
inventories by aggregating to the component level.
• For example, a publisher may drop-ship books that have
been printed on demand, thus reducing the value of
inventory held.
• Although inventory costs are typically low with drop-
shipping, transportation costs are high because
manufacturers are farther from the end consumer.
• With drop-shipping, a customer order including items
from several manufacturers will involve multiple
shipments to the customer.
• This loss in aggregation of outbound transportation also
increases cost.
 Manufacturer Storage with Direct Shipping
Network
Performance Characteristics of Manufacturer Storage with Direct Shipping
Network

Cost Factor Performance

Inventory Lower costs because of aggregation. Benefits of aggregation
are highest for low-demand, high-value items. Benefits are
large if product customization can be postponed at the
manufacturer.
Transportation Higher transportation costs because of increased distance and
disaggregate shipping.
Facilities and Lower facility costs because of aggregation. Some saving on
handling handling costs if manufacturer can manage small shipments
or ship from production line.
Information Significant investment in information infrastructure to
integrate manufacturer and retailer.
 Manufacturer Storage with Direct Shipping
Network

Service Factor Performance

Response time Long response time of one to two weeks because of increased
distance and two stages for order processing. Response time may
vary by product, thus complicating receiving.
Product variety Easy to provide a high level of variety.
Product availability Easy to provide a high level of product availability because of
aggregation at manufacturer.
Customer experience Good in terms of home delivery but can suffer if order from several
manufacturers is sent as partial shipments.
Time to market Fast, with the product available as soon as the first unit is produced.

Order visibility More difficult but also more important from a customer service
perspective.
Returnability Expensive and difficult to implement.
In-Transit Merge Network
 In-Transit Merge Network

• Unlike pure drop-shipping, under which each product in

the order is sent directly from its manufacturer to the
end customer, in-transit merge combines pieces of the
order coming from different locations so the customer
gets a single delivery.

• In-transit merge has been used by Dell and can be used

by companies implementing drop-shipping.
 In-Transit Merge Network

• When a customer ordered a PC from Dell along with

a Sony monitor (during Dell’s direct selling period),
the package carrier picked up the PC from the Dell
factory and the monitor from the Sony factory; it
then merged the two at a hub before making a single
delivery to the customer.
• As with drop-shipping, the ability to aggregate
inventories and postpone product custom- ization is
a significant advantage of in-transit merge.
 In-Transit Merge Network

• In-transit merge allowed Dell and Sony to hold all

their inventories at the factory.
• This approach has the greatest benefits for products
with high value whose demand is difficult to forecast,
particularly if product customization can be
postponed.
• Although an increase in coordination is required, in-
transit merge decreases transportation costs relative
to drop-shipping by aggregating the final delivery.
 In-Transit Merge Network

• The main advantages of in-transit merge over drop-

shipping are lower transportation cost and improved
customer experience.
• The major disadvantage is the additional effort during
the merge itself.
• Given its performance characteristics, manufacturer
storage with in-transit merge is best suited for low- to
medium-demand, high-value items the retailer is sourc-
ing from a limited number of manufacturers.
• Compared with drop-shipping, in-transit merge requires
a higher demand from each manufacturer (not
necessarily each product) to be effective.
 In-Transit Merge

Performance Characteristics of In-Transit Merge

Cost Factor Performance

Inventory Similar to drop-shipping.
Transportation Somewhat lower transportation costs than drop-shipping.
Facilities and handling Handling costs higher than drop-shipping at carrier;
receiving costs lower at customer.
Information Investment is somewhat higher than for drop-shipping.
 In-Transit Merge

Service Factor Performance

Response time Similar to drop-shipping; may be marginally higher.
Product variety Similar to drop-shipping.
Product availability Similar to drop-shipping.
Customer Better than drop-shipping because only a single delivery is
experience received.
Time to market Similar to drop-shipping.
Order visibility Similar to drop-shipping.
Returnability Similar to drop-shipping.
Distributor Storage with Carrier Delivery
 Distributor Storage with Carrier Delivery
• Under this option, inventory is held not by
manufacturers at the factories, but by distributors/
retailers in intermediate warehouses, and package
carriers are used to transport products from the
intermediate location to the final customer.
• Relative to manufacturer storage, distributor storage
requires a higher level of inventory because of a loss of
aggregation.
• From an inventory perspective, distributor storage
makes sense for products with somewhat higher
demand.
 Distributor Storage with Carrier Delivery
• Transportation costs are somewhat lower for
distributor storage compared with those for
manufacturer storage because an economic
mode of transportation (e.g., truckloads) can be
employed for inbound shipments to the
warehouse, which is closer to the customer.
• Distributor storage provides savings on the
transportation of faster-moving items relative to
manufacturer storage.
•
 Distributor Storage with Carrier Delivery

• Response time under distributor storage is better than

under manufacturer storage because distributor
warehouses are, on average, closer to customers, and
the entire order is aggregated at the warehouse before
being shipped.
• Distributor storage with carrier delivery is well suited
for slow- to fast-moving items.
 Distributor Storage with Carrier Delivery

Performance Characteristics of Distributor Storage with Carrier Delivery

Cost Factor Performance

Inventory Higher than manufacturer storage. Difference is not
large for faster-moving items but can be large for very
slow-moving items.
Transportation Lower than manufacturer storage. Reduction is
highest for faster-moving items.
Facilities and Somewhat higher than manufacturer storage. The
handling difference can be large for very-slow-moving items.
Information Simpler infrastructure compared to manufacturer
storage.
 Distributor Storage with Carrier Delivery

Service Factor Performance

Response time Faster than manufacturer storage.
Product variety Lower than manufacturer storage.
Product availability Higher cost to provide the same level of availability as
manufacturer storage.
Customer Better than manufacturer storage with drop-shipping.
experience
Time to market Higher than manufacturer storage.
Order visibility Easier than manufacturer storage.
Returnability Easier than manufacturer storage.
Distributor Storage with Last Mile Delivery
 Distributor Storage with Last Mile Delivery
• Last-mile delivery refers to the distributor/retailer
delivering the product to the customer’s home
instead of using a package carrier.
• AmazonFresh, Peapod, and Tesco have used last-mile
delivery in the grocery industry.
• The automotive spare parts industry is one in which
distributor storage with last-mile delivery is the
dominant model.
• It is too expensive for dealers to carry all spare parts
in inventory.
 Distributor Storage with Last Mile Delivery
• Thus, original equipment manufacturers (OEMs) tend to
carry most spare parts at a local distribution center
typically located no more than a couple of hours’ drive
from their dealers and often managed by a third party.
• The local distribution center is responsible for delivering
needed parts to a set of dealers and makes multiple
deliveries per day.
• Unlike package carrier delivery, last-mile delivery
requires the distributor warehouse to be much closer to
the customer.
•
 Distributor Storage with Last Mile Delivery
• Given the limited radius that can be served with last-mile
delivery, more warehouses are required compared to
when package delivery is used.
• Distributor storage with last-mile delivery requires higher
levels of inventory than the other options (except for
retail stores) because it has a lower level of aggregation.
• Among all the distribution networks, transportation costs
are highest for last-mile delivery, especially when
delivering to individuals.
 Distributor Storage with Last Mile Delivery
• This is because package carriers aggregate delivery
across many retailers and are able to obtain better
economies of scale than are available to a
distributor/retailer attempting last-mile delivery.
• Using this option, facility costs are somewhat lower
than those for a network with retail stores but much
higher than for either manufacturer storage or
distributor storage with package carrier delivery.
• A grocery store using last-mile delivery performs all
the processing until the product is delivered to the
customer’s home, unlike a super- market, where the
customer does much more work.
 Distributor Storage with Last Mile Delivery

Performance Characteristics of Distributor Storage with Last-Mile Delivery

Cost Factor Performance

Inventory Higher than distributor storage with package carrier
delivery.
Transportation Very high cost given minimal scale economies. Higher than
any other distribution option.
Facilities and handling Facility costs higher than manufacturer storage or
distributor storage with package carrier delivery, but lower
than a chain of retail stores.
Information Similar to distributor storage with package carrier delivery.
 Distributor Storage with Last Mile Delivery

Service Factor Performance

Response time Very quick. Same day to next-day delivery.
Product variety Somewhat less than distributor storage with package carrier delivery
but larger than retail stores.
Product availability More expensive to provide availability than any other option except
retail stores.
Customer experience Very good, particularly for bulky items.
Time to market Slightly longer than distributor storage with package carrier delivery.

Order visibility Less of an issue and easier to implement than manufacturer storage
or distributor storage with package carrier delivery.
Returnability Easier to implement than other previous options. Harder and more
expensive than a retail network.
Manufacturer or Distributor Storage with Customer
Pickup
 Manufacturer or Distributor Storage with
Customer Pickup
• In this approach, inventory is stored at the
manufacturer or distributor warehouse, but
customers place their orders online or on the phone
and then travel to designated pickup points to collect
their merchandise.
• Orders are shipped from the storage site to the
pickup points as needed.
• Tesco has implemented such a service in the United
Kingdom, where customers can pick up orders they
have placed online.
 Manufacturer or Distributor Storage with
Customer Pickup
• Amazon is also experimenting with Amazon lockers,
where customers can pick up their shipments.
• Inventory costs using this approach can be kept low, with
either manufacturer or distributor storage to exploit
aggregation.
• Transportation cost is lower than for any solution using
package carriers because significant aggregation is
possible when delivering orders to a pickup site.
• This allows the use of truck- load or less-than-truckload
carriers to transport orders to the pickup site.
 Manufacturer or Distributor Storage with
Customer Pickup
Performance Characteristics of Network with Customer Pickup Sites

Cost Factor Performance

Inventory Can match any other option, depending on the location of
inventory.
Transportation Lower than the use of package carriers, especially if using
an existing delivery network.
Facilities and handling Facility costs can be high if new facilities have to be built.
Costs are lower if existing facilities are used. The increase in
handling cost at the pickup site can be significant.
Information Significant investment in infrastructure required.
 Manufacturer or Distributor Storage with
Customer Pickup

Service Factor Performance

Response time Similar to package carrier delivery with manufacturer or
distributor storage. Same-day pickup is possible for items stored
at regional DC.
Product variety Similar to other manufacturer or distributor storage options.
Product availability Similar to other manufacturer or distributor storage options.
Customer experience Lower than other options because of the lack of home delivery.
Experience is sensitive to capability of pickup location.

Time to market Similar to manufacturer or distributor storage options.

Order visibility Difficult but essential.
Returnability Somewhat easier, given that pickup location can handle returns.
Retail Storage with Customer Pickup
 Retail Storage with Customer Pickup

• In this option, often viewed as the most traditional

type of supply chain, inventory is stored locally at
retail stores.
• Customers walk into the retail store or place an order
online or by phone and pick it up at the retail store.
• Examples of companies that offer multiple options
of order placement include Walmart and Tesco.
• Local storage increases inventory costs because of
the lack of aggregation.
 Retail Storage with Customer Pickup

• For fast- to very- fast-moving items, however, there is

marginal increase in inventory, even with local
storage.
• Walmart uses local storage for its fast-moving
products while delivering a wider variety of products
from its central location for pickup at the store.
 Retail Storage with Customer Pickup

Performance Characteristics of Retail Storage with Customer Pickup Sites

Cost Factor Performance

Inventory Higher than all other options.
Transportation Lower than all other options.
Facilities and handling Higher than other options. The increase in handling cost at
the pickup site can be significant for online and phone
orders.
Information Some investment in infrastructure required for online and
phone orders.
 Retail Storage with Customer Pickup

Service Factor Performance

Response time Same-day (immediate) pickup possible for items stored
locally at pickup site.
Product variety Lower than all other options.
Product availability More expensive to provide than all other options.
Customer Related to whether shopping is viewed as a positive or
experience negative experience by customer.
Time to market Highest among distribution options.
Order visibility Trivial for in-store orders. Difficult, but essential, for online
and phone orders.
Returnability Easier than other options because retail store can provide
a substitute.
 Selecting A Network Design
• A network designer needs to consider product characteristics
as well as network requirements when deciding on the
appropriate delivery network.
• The various networks considered earlier have different
strengths and weaknesses.
• Only niche companies end up using a single distribution
network.
• Most companies are best served by a combination of delivery
networks.
• The combination used depends on product characteristics and
the strategic position that the firm is targeting.
Comparative Performance of Delivery Network
Designs

Comparative Performance Rank of Delivery Network Designs

Blank Retail Manufacturer Manufacturer Distributor Distributor Manufacturer/

Storage with Storage Storage with Storage with Storage with Distributor
Customer with Direct In-Transit Package Last-Mile Storage with
Pickup Shipping Merge Carrier Delivery Customer
Delivery Pickup
Response 1 4 4 3 2 4
time
Product 4 1 1 2 3 1
variety
Product 4 1 1 2 3 1
availability
Comparative Performance of Delivery Network
Designs

Blank Retail Manufacturer Manufacturer Distributor Distributor Manufacturer/

Storage with Storage Storage with Storage with Storage with Distributor
Customer with Direct In-Transit Package Last-Mile Storage with
Pickup Shipping Merge Carrier Delivery Customer
Delivery Pickup
Customer Varies From 1 4 3 2 1 5
experience to 5
Time to market 4 1 1 2 3 1

Order visibility 1 5 4 3 2 6

Returnability 1 5 5 4 3 2
Comparative Performance of Delivery Network
Designs

Blank Retail Manufacturer Manufacturer Distributor Distributor Manufacturer/

Storage with Storage Storage with Storage with Storage with Distributor
Customer with Direct In-Transit Package Last-Mile Storage with
Pickup Shipping Merge Carrier Delivery Customer
Delivery Pickup
Inventory 4 1 1 2 3 1

Transportation 1 4 3 2 5 1

Facility and 6 1 2 3 4 5
handling
Information 1 4 4 3 2 5

Key: 1 corresponds to the best performance and 6 the worst performance.

Delivery Networks for Different Product/
Customer Characteristics
Performance of Delivery Networks for Different Product/Customer
Characteristics

Blank Retail Manufacturer Manufacturer Distributor Distributor Manufacturer/

Storage with Storage Storage with Storage with Storage with Distributor
Customer with Direct In-Transit Package Last-Mile Storage with
Pickup Shipping Merge Carrier Delivery Customer
Delivery Pickup
High-demand +2 −2 −1 0 +1 −1
product

Medium-demand +1 −1 0 +1 0 0
product

Low-demand −1 +1 0 +1 −1 +1
Product
Delivery Networks for Different Product/
Customer Characteristics

Blank Retail Manufacturer Manufacturer Distributor Distributor Manufacturer/

Storage with Storage Storage with Storage with Storage with Distributor
Customer with Direct In-Transit Package Last-Mile Storage with
Pickup Shipping Merge Carrier Delivery Customer
Delivery Pickup

Very-low-demand −2 +2 +1 0 −2 +1
product
High product value −1 +2 +1 +1 0 +2

Quick desired +2 -2 −2 −1 +1 -2
response
High product variety −1 +2 0 +1 0 +2

Low customer effort −2 +1 +2 +2 +2 −1

Key: +2 = very suitable; +1 = somewhat suitable; 0 = neutral; −1 = somewhat unsuitable; −2 = very

unsuitable.
 To Sum Up
•Distribution networks that ship directly to the
customer are better suited for a large variety of high-
value products that have low and uncertain demand.
•These networks incur lower facility costs and carry low
levels of inventory but incur high transportation cost
and provide a slow response time.
• Distribution networks that carry local inventory are
suitable for products with high demand, especially if
transportation is a large fraction of total cost.
•These networks incur higher facility and inventory cost
but lower transportation cost and provide a faster
response time.