Facility Location & Network Optimization

Often companies determine their new warehouse locations or factory locations (which we will summarize as facility locations) based on criteria such as cities they are familiar with from business travel or where they would like to grow their business. These may be good reasons. However, very few business decisions are as important, and strategic as locating your warehouse or factory. They have an impact on your customers and company for many years.

When locating your warehouse or factory perhaps the most important concept to know is the efficient frontier. This is the tradeoff of cost versus service. Generally, having more facilities will improve service (speed to delivery) to customers. However more facilities, even if they are smaller, will increase costs due to economies of scale in facility expenses. (Bigger facilities can allocate overhead across more units.) You can have a low-cost / low service level network design, or a high-cost / high service design. However, a high-cost and low service design is sure to lose, especially if your competitors are optimizing their networks.

The way to solve this problem is to optimize your facility locations and your entire supply chain network. The network includes your facilities, your suppliers’ facilities and your customers’ locations. Optimization is a mathematical methodology that can quickly determine the absolute best answer. In facility location optimization we are typically either trying to maximize profit or minimize costs by deciding where to locate our warehouses or factories, and assigning customers to be served by these facilities. The consideration of customer service is handled by making sure your network can achieve a minimum delivery time to all customers. You can experiment with this parameter to understand the tradeoff of cost versus service.

Elements of a facility optimization model include:

1. Inputs
   1. Candidate facility’s locations (including current and potential sites)
   2. Inbound shipping costs
   3. Outbound shipping costs
   4. Outbound delivery times
   5. Total facility costs (current and potential sites) of different locations and different sizes
   6. Inventory costs associated with different size facilities
2. Decision Outputs
   1. Which facilities should be chosen
   2. Optional: Determine the size of the facility based on capacity
   3. Assign customers to a chosen facility
   4. Optional: Assign which suppliers’ locations should serve each chosen facility
3. Objective Function
   1. Maximize profit (the best combination of facilities maximizing captured sales and minimizing all operating costs)
   2. Minimize operating costs (doesn’t consider competitors locations or capturing market share based on your facility locations)
4. Constraints
   1. In order to consider the tradeoff of costs versus service we would add a delivery time constraint to serve all customers
   2. Other constraints can include the maximum investment for opening new facilities

When the model is built, Supply Velocity will run sensitivity analyses to ensure a full understanding of the problem, given variation of inputs such as transportation costs and market share assumptions. The facility location – network optimization model will support wiser facility location decisions.