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14.4 DESIGN OPTIONS FOR A TRANSPORTATION NETWORK

The design of a transportation network affects the performance of a supply chain by establishing the infrastructure within which operational transportation decisions regarding scheduling and routing are made. A well-designed transportation network allows a supply chain to achieve the desired degree of responsiveness at a low cost. Three basic questions need to be considered when designing a transportation network between two stages of a supply chain:

1. Should transportation be direct or through an intermediate site? 2. Should the intermediate site stock product or only serve as a cross-docking location? 3. Should each delivery route supply a single destination or multiple destinations (milk run)?

Based on the answers to these questions, the supply chain ends up with a variety of trans- portation networks. We discuss these options and their strengths and weaknesses in the context of a buyer with multiple locations sourcing from several suppliers.

Direct Shipment Network to Single Destination

With the direct shipment network to a single destination option, the buyer structures the transportation network so that all shipments come directly from each supplier to each buyer location, as shown in Figure 14-2. With a direct shipment network, the routing of each shipment is specified, and the supply chain manager needs to decide only the quantity to ship and the mode of transportation to use. This decision involves a trade-off between transportation and inventory costs, as discussed later in the chapter.

The major advantage of a direct shipment transportation network is the elimination of inter- mediate warehouses and its simplicity of operation and coordination. The shipment decision is completely local, and the decision made for one shipment does not influence others. The transportation time from supplier to buyer location is short because each shipment goes direct.

A direct shipment network to single destination is justified only if demand at buyer locations is large enough that optimal replenishment lot sizes are close to a truckload from each supplier to each location. Home Depot started with a direct shipment network, given that most of the stores it opened until about 2002 were large stores. The stores ordered in quantities that were large enough that ordering was managed locally within the store and delivery to the store arrived directly from the supplier. The direct shipment network to single destination, however, proved to be problematic as Home Depot started to open smaller stores that did not have large enough orders to justify a direct shipment.

Suppliers Buyer Locations

FIGURE 14-2 Direct Shipment Network

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Suppliers Buyer Locations Buyer LocationsSuppliers

FIGURE 14-3 Milk Runs from Multiple Suppliers or to Multiple Buyer Locations

Direct Shipping with Milk Runs

A milk run is a route on which a truck either delivers product from a single supplier to multiple retailers or goes from multiple suppliers to a single buyer location, as shown in Figure 14-3. In direct shipping with milk runs, a supplier delivers directly to multiple buyer locations on a truck or a truck picks up deliveries destined for the same buyer location from many suppliers. When using this option, a supply chain manager has to decide on the routing of each milk run.

Direct shipping provides the benefit of eliminating intermediate warehouses, whereas milk runs lower transportation cost by consolidating shipments to multiple locations on a single truck. Milk runs make sense when the quantity destined for each location is too small to fill a truck but multiple locations are close enough to each other such that their combined quantity fills the truck. Companies such as Frito-Lay that make direct store deliveries use milk runs to lower their transportation cost. If frequent small deliveries are needed on a regular basis and either a set of suppliers or a set of retailers is in geographic proximity, the use of milk runs can significantly reduce transportation costs. For example, Toyota uses milk runs from suppliers to support its just-in-time (JIT) manufacturing system in both Japan and the United States. In Japan, Toyota has many assembly plants located close together and thus uses milk runs from a single supplier to many plants. In the United States, however, Toyota uses milk runs from many suppliers to each assembly plant given the large distance between assembly plants.

All Shipments via Intermediate Distribution Center with Storage

Under this option, product is shipped from suppliers to a central distribution center where it is stored until needed by buyers when it is shipped to each buyer location, as shown in Figure 14-4. Storing product at an intermediate location is justified if transportation economies require large shipments on the inbound side or shipments on the outbound side cannot be coordinated. In such a situation, product comes into a DC in large quantities where it is held in inventory and sent to buyer locations in smaller replenishment lots when needed.

The presence of a DC allows a supply chain to achieve economies of scale for inbound transportation to a point close to the final destination, because each supplier sends a large shipment to the DC that contains product for all locations the DC serves. Because DCs serve locations nearby, the outbound transportation cost is not very large. For example, W.W. Grainger has its suppliers ship products to one of nine DCs (typically in large quantities), with each DC in turn replenishing stores in its vicinity with the smaller quantities they need.

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Suppliers Buyer Locations

DC

FIGURE 14-4 All Shipments via DC

It would be expensive for suppliers to try and serve each store directly. Similarly, when Home Depot sources from an overseas supplier, the product is held in inventory at the DC because the lot size on the inbound side is much larger than the sum of the lot sizes for the stores served by the DC.

All Shipments via Intermediate Transit Point with Cross-Docking

Under this option, suppliers send their shipments to an intermediate transit point (could be a DC) where they are cross-docked and sent to buyer locations without storing them. The product flow is similar to that shown in Figure 14-4 except that there is no storage at the intermediate facility. When a DC cross-docks product, each inbound truck contains product from suppliers for several buyer locations, whereas each outbound truck contains product for a buyer location from several suppliers. Major benefits of cross-docking are that little inventory needs to be held and product flows faster in the supply chain. Cross-docking also saves on handling cost because product does not have to be moved into and out of storage. Cross-docking is appropriate when economies of scale in transportation can be achieved on both the inbound and outbound sides and both inbound and outbound shipments can be coordinated.

Wal-Mart has used cross-docking successfully to decrease inventories in the supply chain without incurring excessive transportation costs. Wal-Mart builds many large stores in a geographic area supported by a DC. As a result, the total lot size to all stores from each supplier fills trucks on the inbound side to achieve economies of scale. On the outbound side, the sum of the lot sizes from all suppliers to each retail store fills up the truck to achieve economies of scale.

Another good example of the use of a transit point with cross-docking comes from Peapod in the Chicago area. Peapod has a DC in Lake Zurich from which it delivers to its customers using milk runs. This approach proved effective for customers in the northern and western sub- urbs of Chicago. Peapod, however, wanted to increase its reach to the city of Chicago and the city of Milwaukee. Both are far enough from the Lake Zurich DC that a milk run wasted about two hours in transit making no productive deliveries. These markets were also small enough that they did not justify a local DC. Peapod’s response has been to set up a cross-docking facility (which tends to be cheaper than a DC because no storage is involved) at each location. Peapod then sends out all deliveries to the local cross-dock facility in a larger truck and uses smaller trucks for local deliveries. The use of cross-docking at a transit point has allowed Peapod to increase the reach of the Lake Zurich DC without significantly increasing transportation expense.

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DC

FIGURE 14-5 Milk Runs from DC

Shipping via DC Using Milk Runs

As shown in Figure 14-5, milk runs can be used from a DC if lot sizes to be delivered to each buyer location are small. Milk runs reduce outbound transportation costs by consolidating small shipments. For example, Seven-Eleven Japan cross-docks deliveries from its fresh-food suppliers at its DCs and sends out milk runs to the retail outlets because the total shipment to a store from all suppliers does not fill a truck. The use of cross-docking and milk runs allows Seven-Eleven Japan to lower its transporta- tion cost while sending small replenishment lots to each store. The use of cross-docking with milk runs requires a significant degree of coordination and suitable routing and scheduling.

The online grocer Peapod uses milk runs from DCs when making customer deliveries to help reduce transportation costs for small shipments to be delivered to homes. OshKosh B’Gosh, a manufacturer of children’s wear, has used this idea to virtually eliminate LTL shipments from its DC in Tennessee to retail stores.

Tailored Network

The tailored network option is a suitable combination of previous options that reduces the cost and improves responsiveness of the supply chain. Here transportation uses a combination of cross-docking, milk runs, and TL and LTL carriers, along with package carriers in some cases. The goal is to use the appropriate option in each situation. High-demand products to high- demand retail outlets may be shipped directly, whereas low-demand products or shipments to low-demand retail outlets are consolidated to and from the DC. The complexity of managing this transportation network is high because different shipping procedures are used for each product and retail outlet. Operating a tailored network requires significant investment in information infrastructure to facilitate the coordination. Such a network, however, allows for the selective use of a shipment method to minimize the transportation as well as inventory costs.

Table 14-2 summarizes the pros and cons of the various transportation network options discussed. We illustrate some of these choices in Example 14-1.

Selecting a Transportation Network

A retail chain has eight stores in a region supplied from four supply sources. Trucks have a capacity of 40,000 units and cost $1,000 per load plus $100 per delivery. Thus, a truck making two deliveries charges $1,200. The cost of holding one unit in inventory at retail for a year is $0.20.

EXAMPLE 14-1

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Demand Curve

Average cost of time + operation

Marginal cost of time + operation

Vehicle Flow Rate

P ri

ce o

f T

ri p

Q1 Q0

P0 P1 A

B

FIGURE 14-1 Impact of Average and Marginal Cost on Vehicle Flow

From these examples, it seems reasonable that the government has to either own or regulate a monopolistic transportation infrastructure asset. When the transportation infrastructure asset has competition either within a mode or across modes, private ownership, deregulation, and competition seem to work well. The deregulation of the transportation industry within the United States is a case in point. Keep in mind, however, that roads, ports, and airports are largely public and not private because of the inherently monopolistic nature of these transportation infrastructure assets. In such a setting, the public ownership of these assets is justified. This raises the policy question of financing the construction and maintenance of these publicly owned transportation assets. Should roads be financed through a gasoline tax, or is some other form of financing such as tolls more appropriate?

Some economists have argued for public ownership of these assets with the setting of quasi-market prices to improve overall efficiency. Quasi-market prices need to take into account the discrepancy between the incentives of an individual using the transportation infrastructure and the public as a whole that owns the infrastructure. This discrepancy is illustrated in Figure 14-1 in the context of road traffic.

A vehicle driver bases his or her decision to use a highway on the cost and benefit of doing so. Figure 14-1 assumes that different people have different value for making the trip and this value is uniformly distributed over an interval. The number of users whose value from a trip exceeds a particular cost is thus defined by the demand curve. We assume a sim- ple demand curve given by traffic f ! 1,000 " cost. The costs incurred by a motorist include any tolls and the cost of time spent on the highway and the cost of operating and maintaining the vehicle. It is well known that the time spent increases with congestion on a highway. Thus, the average cost to each motorist increases with traffic flow as shown in Figure 14-1. We start with the case when there are no tolls and motorists only incur costs related to congestion, operation, and maintenance. We assume that the total cost grows with traffic f and is given by total cost ! 3f 2. The average cost per motorist is thus given by cost = 3f 2# f ! 3f. Since there are no tolls for accessing the highway, demand will materialize based on the average congestion, operation, and maintenance cost incurred by people on the road. Given people’s valuation of the trip, the number of motorists using the road is determined by the intersection of the demand curve with the average cost curve at point A as shown in Figure 14-1. For our demand curve f ! 1,000 – cost and average cost function cost ! 3f, we obtain f ! 1,000 " cost ! 1,000 – 3f. Solving this equation for f, we obtain f ! 1,000#4 ! 250 motorists at equilibrium. This results in an average cost to motorists of P0 ! 3f ! 3 ! 250 ! 750 and a traffic flow of Q0 ! f ! 250.

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