Today, I’d like to discuss distribution networks shapes. A distribution network is a channel that a company uses to get its products from the manufacturer to the end customer. The shape of this distribution network could vary from a small and simple size network to very complicated networks such as power grid network. The factors that are involved in defining the shape of the distribution network are end customer product demands, product variety, product availability, response time, returnability, and customer experience. Among these factors, response time gets higher weight in establishing the distribution shape. Response times are the time between when a customer places an order and receives delivery.
If customers can tolerate a large response time, fewer locations are required in a distribution channel and the emphasis would be on the larger capacity at each location. However, if customers require short response times then the more locations should be built in the network. Changing the distribution network is something that a company is often reluctant to do in short range since it has direct impact on supply chain cost elements such as inventories, transportation, facilities and handling. But it is just a matter of time and sooner or later a company needs to reshape its distribution network.
As a rule of thumb we can say, the more facilities in a network, it causes more inventory costs but less shipping costs. In opposite, the less number of facilities would lead to less facility overhead cost but more transportation costs for remote customers. So if we assume the distribution costs are a summation of facility and transportation costs and call it logistic costs, then would these two elements be enough to configure the shape of the distribution network? Where would the response times fit in this equation?
There is no doubt that a minimum number of locations are required to minimize the logistic costs but in order to be more agile and quick to respond to market changes an organization should go beyond the cost minimization.
Figure 1 shows that the extra number of facilities would bring quicker response times to market albeit of increasing the logistic costs. But, the main question would be: where are the tradeoffs? To answer this question let’s take a look at the response time and supply relationship. Supply is a factor of time because the supplier cannot react quickly to a demand change. So it is really important to see if the demand change is temporary or permanent. For example one should investigate whether the demand increase for umbrellas is because of the one rainy season or is it because of the climate change. So a key factor to evaluate the required supply is predicting the demand shape.
In figure 2, the demand shape has a sinus pattern and depends on the economic and market condition, the slope of peak or downturn changes time to time. However, the trend of the demand is more stable in longer periods of time and would be a good indicator that market is expanding or retracting. It is really important for the company to know its product demand shape in the next five to ten years and adjust its supply chain accordingly, so that they may respond to market change quicker. In the expansion period, a company may wish to build a new infrastructure in other geographical areas (market penetration) and in a downturn, would decide to consolidate the duplicate distribution systems created at an earlier time. This wave is what to consider for response times.
Back to my original question, “where is the tradeoff between the response times and logistic costs?” I can say it depends on where the company stands on its demand shape. In expansion periods, it makes sense to go beyond the logistic cost and penetrate fiercely into the market to achieve quicker response times even though the logistic costs are higher. In the maturity phase of the demand shape, the best strategy is to keep the response times as level as minimum logistic cost and finally in the downturn period it wouldn’t be the worst idea to sacrifice the response time by saving some buckets in logistic costs.