DryIce, Inc.

, is a manufacturer of air conditioners that has seen its demand grow

significantly. The company anticipates nationwide demand for the next year to be 180,000

units in the South, 120,000 units in the Midwest, 110,000 units in the East, and 100,000

units in the West. Managers at DryIce are designing the manufacturing network and have

selected four potential sites—New York, Atlanta, Chicago, and San Diego. Plants could

have a capacity of either 200,000 or 400,000 units. The annual fixed costs at the four

locations are shown in Table 5-6, along with the cost of producing and shipping an air

conditioner to each of the four markets. Where should DryIce build its factories and how

large should they be?

A manager’s goal when locating facilities and allocating capacity should be to maximize the

overall profitability of the resulting supply chain network while providing customers with the

appropriate responsiveness. Revenues come from the sale of product, whereas costs arise from

facilities, labor, transportation, material, and inventories. The profits of the firm are also affected

by taxes and tariffs. Ideally, profits after tariffs and taxes should be maximized when designing a

supply chain network. A manager must consider many trade-offs during network design. For

example, building many facilities to serve local markets reduces transportation cost and provides

a fast response time, but it increases the facility and inventory costs incurred by the firm.

Managers use network design models in two situations. First, these models are used to decide on

locations where facilities will be established and determine the capacity to be assigned to each

facility. Managers must make this decision considering a time horizon over which locations and

capacities will not be altered (typically in years). Second, these models are used to assign current

demand to the available facilities and identify lanes along which product will be transported.
Managers must consider this decision at least on an annual basis as demand, prices, exchange

rates, and tariffs change. In both cases, the goal is to maximize the profit while satisfying

customer needs. The following information ideally is available in making the design decision:

Location of supply sources and markets Location of potential facility sites Demand forecast by

market Facility, labor, and material costs by site Transportation costs between each pair of sites

Inventory costs by site and as a function of quantity Sale price of product in different regions

Taxes and tariffs Desired response time and other service factors Given this information, either

gravity models or network optimization models may be used to design the network. We organize

the models according to the phase of the network design framework at which each model is

likely to be useful.

During Phase II of the network design framework (see Figure 5-2), a manager considers regional

demand, tariffs, economies of scale, and aggregate factor costs to decide the regions where

facilities are to be located. As an example, consider SunOil, a manufacturer of petrochemical

products with worldwide sales. The vice president of supply chain is considering several options

to meet demand. One possibility is to set up a facility in each region. The advantage of such an

approach is that it lowers transportation cost and also helps avoid duties that may be imposed if

product is imported from other regions. The disadvantage of this approach is that plants are sized

to meet local demand and may not fully exploit economies of scale. An alternative approach is to

consolidate plants in just a few regions. This improves economies of scale but increases

transportation cost and duties. During Phase II, the manager must consider these quantifiable

trade-offs along with nonquantifiable factors such as the competitive environment and political

risk. Network optimization models are useful for managers considering regional configuration

during Phase II. The first step is to collect the data in a form that can be used for a quantitative
model. For SunOil, the vice president of supply chain decides to view the worldwide demand in

terms of five regions—North America, South America, Europe, Africa, and Asia. The data

collected are shown in Figure 5-3. Annual demand for each of the five regions is shown in cells

B9:F9. Cells B4:F8 contain the variable production, inventory, and transportation cost (including

tariffs and duties) of producing in one region to meet demand in each individual region. All costs

are in thousands of dollars. For example, as shown in cell C4, it costs $92,000 (including duties)

to produce 1 million units in North America and sell them in South America. As shown in cell

G4, it costs $6 million in annualized fixed cost to build a low-capacity plant in North America.

Observe that the data collected at this stage are at a fairly aggregate level.

There are fixed as well as variable costs associated with facilities, transportation, and inventories

at each facility. Fixed costs are those that are incurred no matter how much is produced or

shipped from a facility. Variable costs are those that are incurred in proportion to the quantity

produced or shipped from a given facility. Facility, transportation, and inventory costs generally

display economies of scale, and the marginal cost decreases as the quantity produced at a facility

increases. In the models we consider, however, all variable costs grow linearly with the quantity

produced or shipped. SunOil is considering two plant sizes in each location. Low-capacity plants

can produce 10 million units a year, whereas high-capacity plants can produce 20 million units a

year, as shown in cells H4:H8 and J4:J8, respectively. High-capacity plants exhibit some

economies of scale and have fixed costs that are less than twice the fixed costs of a low-capacity

plant, as shown in cells I4:I8. All fixed costs are annualized. The vice president wants to know

what the lowest-cost network should look like. To answer this question, we next discuss the

capacitated plant location model, which can be used in this setting.

model requires the following inputs: n = number of potential plant locations/capacity (each level

of capacity will count as a separate location) m = number of markets or demand points Dj =

annual demand from market j Ki = potential capacity of plant i fi = annualized fixed cost of

keeping plant i open cij = cost of producing and shipping one unit from plant i to market j (cost

includes production, inventory, transportation, and tariffs) The supply chain team’s goal is to

decide on a network design that maximizes profits after taxes. For the sake of simplicity,

however, we assume that all demand must be met and taxes on earnings are ignored. The model

thus focuses on minimizing the cost of meeting global demand. It can be modified, however, to

include profits and taxes. Define the following decision variables: yi = 1 if plant i is open, 0

otherwise xij = quantity shipped from plant i to market j