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attempt to find the optimum flows and the optimum number of DCs to serve a system.
It is worthwhile to begin the discussion by concentrating on the most practical aspects of importance to an individual company. The main point to appreciate is that the vast majority of location studies are undertaken when the company already has a number of DCs and associated delivery areas. Thus, location studies are rarely based upon the premise that the 'best' results can be applied at the end of the day. Generally, it is necessary for a compromise to be reached between what is 'best' and what is currently in existence. The very high cost of DCs and vehicle fleets is the main reason for this, as well as the high cost and great disruption involved in making any changes to existing systems.
Despite this, it is very important for companies to know how their distribution networks might be improved. Although some networks are planned from the beginning of a company's operation, this is a rare occurrence. The majority of systems are unplanned; they just evolve very much as the company evolves. This may be a steady growth (or decline), or may be in short steps or large leaps as mergers and takeovers occur. Perhaps the most common reason why logistics networks are out of balance is that of inertia, because of the great amount of work and effort required to make changes. It needs a forward-looking management or a particularly significant change for a company to undertake a large-scale study of this nature. The recent realization of the importance of logistics to most companies, and the need to cut costs and improve efficiency, have provided sufficient impetus for a number of companies to review their logistics and distribution structure with a particular emphasis on the use and location of DCs and warehouses.
The role of distribution centres and warehouses
There are a number of reasons why DCs and warehouses are required. These vary in importance depending on the nature of a company's business. In general, the main reasons are:
•to hold the inventory that is produced from long production runs. Long production runs reduce production costs by minimizing the time spent for machine set-up and changeover, enabling 'lean' manufacturing.
•to hold inventory and decouple demand requirements from production capabilities. This helps to smooth the flow of products in the supply chain and assists in operational efficiency, enabling an 'agile' response to customer demands.
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Note that many supply chains have strategic inventory located at several different points, whereas this buffer only needs to be held at what is known as the decoupling point: the point at which discrete product orders are received.
•to hold inventory to enable large seasonal demands to be catered for more economically.
•to hold inventory to help provide good customer service.
•to enable cost trade-offs with the transport system by allowing full vehicle loads to be used.
•to facilitate order assembly.
These reasons emphasize the importance of the facilities location decision, and also give an indication of the complex nature of that decision. It is possible to summarize the main reason for developing a logistics network as 'the need to provide an effective service to the customer, whilst minimizing the cost of that service'. Service and cost factors are thus of paramount importance when determining the number, size and location of facilities.
For the best possible customer service, a DC would have to be provided right next to the customer, and it would have to hold adequate stocks of all the goods the customer might require. This would obviously be a very expensive solution. At the other extreme, the cheapest solution would be to have just one DC (or central warehouse) and to send out a large truck to each customer whenever his or her orders were sufficient to fill the vehicle so that an economic full load could be delivered. This would be a cheap alternative for the supplier, but as deliveries might then only be made to a customer once or maybe twice a year, the supplier might soon lose the customer's business.
There is obviously a suitable compromise somewhere between these extremes. This will usually consist of the provision of a number of DCs on a regional or area basis, and the use of large primary (line-haul) vehicles to service these, with smaller vehicles delivering the orders to customers. For certain operations, of course, even these simple relationships will vary because of the need for very high levels of customer service or the very high value of products. In addition, it should be noted that there are a number of different types of DC, each of which might be considered in the planning of a suitable physical distribution structure. These might include:
• finished goods DCs/warehouses — these hold the stock from factories;
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•distribution centres, which might be central, regional (RDC), national (NDC) or local DCs— all of these will hold stock to a greater or lesser extent;
•trans-shipment sites or stockless, transit or cross-docking DCs — by and large, these do not hold stock, but act as intermediate points in the distribution operation for the transfer of goods and picked orders to customers;
•seasonal stock-holding sites;
•overflow sites.
Logistics network and DC location strategies are aimed at establishing the most appropriate blend of storage and transport at a given customer service level. The interrelationship of the different distribution elements and their associated costs thus provide the basis for decision making.
Cost relationships
To plan an efficient logistics structure, it is necessary to be aware of the interaction between the different distribution costs, specifically as to how they vary with respect to the different site alternatives (number, size, type and location), and what the overall logistics cost will be. This is best done by comparative analysis of the major alternative configurations. Before this can be achieved, the detailed make-up of the individual distribution cost elements must be understood. Many companies have cost information based on their conventional accounting systems, but almost always these costs are too general to allow for any detailed breakdown into the integral parts that reflect the company's distribution structure. Without this information, and the understanding that goes with it, it is impossible to measure the effectiveness or otherwise of the existing operation. It is also impossible to gain the necessary insight into the distribution operation to allow for successful planning and management. The component parts of a distribution system necessarily interact with one another to form the system as a whole. Within this system, it is possible to trade off one element with another, and so gain an overall improvement in the costeffectiveness of the total system. An appreciation of the make-up and relationship of these key costs is thus a vital link to successful distribution planning and operations.
The major cost relationships are outlined in this section, starting with storage and warehousing costs. The major cost breakdown is between building, building services, labour, equipment and management/supervision. The relationship of these costs will, of course, vary under different circumstances — industry, product type,
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volume throughput, regional location, age of building, handling system, etc. In general, the direct labour cost is likely to be the greatest element, with the building cost likely to fluctuate from very high (new building, prime location) to very low (old building, peppercorn (low) rent, low rates or local taxes).
With respect to the cost relationship of warehousing with other parts of the distribution system, the importance of storage and warehousing costs will be dependent on such factors as the size of the DC and the number of DCs within the distribution network as a whole.
The effect of site size is illustrated by the economies of scale experienced if larger
DCs are operated. It has been established that the cost of operation of a site and the amount of stock required to support a DC tend to be higher (per unit) for a small site than for a large one. This is because larger DCs can often achieve better space and equipment utilization and can benefit from spreading overhead costs over the higher throughput. With stock-holding, the larger a site, the less buffer and safety stock is required. It should be noted that, eventually, diseconomies of scale could occur, because very large DCs can be adversely affected by such conditions as excessive internal travel distances, problems of management, etc.
The effect of a different number of warehouses or DCs in a given distribution network can be seen by developing the economies of scale argument. If a distribution network is changed from one site to two sites, then the overall DC/storage costs will increase. The change is likely to be from a single large site to two mediumsized sites. This will not, therefore, double the costs, because the change is not to two large DCs. It will certainly increase costs, however, because there will be a need for more stock coverage, more storage space, more management, etc.
One point that should be appreciated is that some care must be taken over any generalization of this nature. In practice, it will be found that each individual site may differ in its cost structure from the other sites in a system for a variety of practical reasons. These may include, for example, high (or low) rent and rates according to the locality of the DC (eg very high in cities) or high (or low) labour costs.
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The two most important categories of transport costs are primary (trunking/linehaul) and secondary (final) delivery. These are affected differently according to the number of DCs in a distribution network.
Delivery transport is concerned with the delivering of orders from the DC to the customer. This can be carried out by a company using its own fleet of vehicles or by a third-party carrier. Whichever alternative is used, the cost of delivery is essentially dependent on the distance that has to be travelled. Delivery distance can be divided into two types: 1) 'drop' distance, which is the distance travelled once a drop or delivery zone has been reached; and 2) 'stem' distance, which is the distance to and from a delivery zone. Whilst the 'drop' distance remains the same whatever the distance from the supplying DC, the 'stem' distance varies according to the number of DCs in the system. The greater the number of sites, the less the stem distance.
The primary transport element is the supply of products in bulk (i.e. in full pallet loads) to the DCs from the central finished goods warehouse or production point. Once again, the number of sites affects the overall cost of this type of transport. In this instance, the effect is not a particularly large one, but it does result in an increase in primary transport costs as the number of DCs increases. The effect is greatest where there is a smaller number of sites.
If the costs for both primary and delivery transport are taken as a combined transport cost then the total transport costs can be related to the different number of DCs in a distribution network. The overall effect of combining the two transport costs is that total transport costs will reduce, the greater the number of sites that there are in the system.
Another important cost that needs to be included is the cost of holding inventory. The key costs can be broken down into four main areas:
1.Capital cost — the cost of the physical stock. This is the financing charge, which is the current cost of capital to a company or the opportunity cost of tying up capital that might otherwise be producing a return if invested elsewhere.
2.Service cost — that is, stock management and insurance.
3.Risk costs — which occur through pilferage, deterioration of stock, damage and stock obsolescence.
4.Storage costs