Designing the Distribution Network for Michael’s Hardware Ellen Lin, vice presid
ID: 333314 • Letter: D
Question
Designing the Distribution Network for Michael’s Hardware
Ellen Lin, vice president of supply chain at Michael’s Hardware, was looking at the financial results from the past quarter and thought that the company could significantly improve its distribution costs, especially given the recent expansion into Arizona. Transportation costs had been very high, and Ellen believed that moving away from LTL shipping to Arizona would help lower transportation costs without significantly raising inventories.
Michael’s had 32 stores each in Illinois and Arizona and sourced its products from eight suppliers located in the Midwest. The company began in Illinois and its stores in the state enjoyed strong sales. Each Illinois store sold, on average, 50,000 units a year of product from each supplier (for annual sales of 400,000 units per store). The Arizona operation was started about five years ago and still had plenty of room to grow. Each Arizona store sold 10,000 units a year from each supplier (for annual sales of 80,000 units per store). Given the large sales at its Illinois stores, Michael’s followed a direct-ship model and shipped small truckloads (with a capacity of 10,000 units) from each supplier to each of its Illinois stores. Each small truck cost $450 per delivery from a supplier to an Illinois store and could carry up to 10,000 units. In Arizona, however, the company wanted to keep inventories low and used LTL shipping that required a minimum shipment of only 500 units per store but cost $0.50 per unit. Holding costs for Michael’s were $1 per unit per year.
Ellen asked her staff to propose different distribution alternatives for both Illinois and Arizona.
Distribution Alternatives for Illinois
Ellen’s staff proposed two alternative distribution strategies for the stores in Illinois:
Use direct shipping with even larger trucks that had a capacity of 40,000 units. These trucks charged only $1,150 per delivery to an Illinois store. Using larger trucks would lower transportation costs but increase inventories because of the larger batch sizes.
Run milk runs from each supplier to multiple stores in Illinois to lower inventory cost even if the cost of transportation increased. Large trucks (capacity of 40,000 units) would charge $1,000 per shipment and a charge of $150 per delivery. Small trucks (capacity of 10,000 units) would charge $400 per shipment and a charge of $50 per delivery.
Distribution Alternatives for Arizona
Ellen’s staff had three distribution alternatives for the stores in Arizona:
Use direct shipping with small trucks (capacity of 10,000 units) as was currently being done in Illinois. Each small truck charged $2,050 for a shipment of up to 10,000 units from a supplier to a store in Arizona. This was a significantly lower transportation cost than was currently being charged by the LTL carrier. This alternative, however, would increase inventory costs in Arizona given the larger batch sizes.
Run milk runs using small trucks (capacity of 10,000 units) from each supplier to multiple stores in Arizona. The small truck carrier charged $2,000 per shipment and $50 per delivery. Thus, a milk run from a supplier to four stores would cost $2,200. Milk runs would incur higher transportation costs than direct shipping but would keep inventory costs lower.
Use a third-party cross-docking facility in Arizona that charged $0.10 per unit for this cross-docking service. This would allow all suppliers to ship product (destined for all 32 Arizona stores) using a large truck to the cross-dock facility, where it would be cross-docked and sent to stores in smaller trucks (each smaller truck would now contain product from all eight suppliers). Large trucks (capacity of 40,000 units) charge $4,150 from each supplier to the cross-dock facility. Small trucks (capacity of 10,000 units) charge $250 from the cross-dock facility to each retail store in Arizona.
Ellen wondered how best to structure the distribution network and whether the savings would be worth the effort. If she used milk runs in either region, she also had to decide on how many stores to include in each milk run.
Study Questions
What is the annual distribution cost of the current distribution network? Include transportation and inventory costs.
How should Ellen structure distribution from suppliers to the stores in Illinois? What annual savings can she expect?
How should Ellen structure distribution from suppliers to the stores in Arizona? What annual savings can she expect?
What changes in the distribution network (if any) would you suggest as both markets grow?
Explanation / Answer
Batch Size=1000
No of shipments per year=5
Average inventory=50000
Total truck cost=576000
Truck cost per retail store per supplier=2250
Total holding cost=12800000
Total holding and truck cost=13376000
The total transportation cost= 8*32*10000*0.5 = 1280000
Holding cost, considering batch of 500 is used for each store= (500/2)*8*32=64000
Total annual cost = 1280000 + 64000= $ 1344000
2. For Illinois:
Considering Batch Size =4
No of stops = 2500
No of shipments per store per year =20
Average inventory at store per product = 1250
Truck cost per retail store per supplier for 1 year=3000
Total truck cost per year = 768000
Holding cost=1250
Total holding cost = 320000
So, total truck and holding cost = $1088000
And total saving = $768000
3. For Arizona:
Considering Batch Size =10
No of stops = 1000
No of shipments per store per year =20
Average inventory at store per product = 500
Truck cost per retail store per supplier for 1 year=2500
Total truck cost per year = 640000
Holding cost=500
Total holding cost = 128000
So, total truck and holding cost = $768000
And total saving = $576000
4. If the Illinois market expects growth, we can expect the number of stores allocated to a single truck to reduce. If the demand quadruples in the market, the optimal number of stores per milk run may decrease up to 2.
For Arizona market, if there is market growth, the intermediate facilities might diminish. The demand must increase up to 10 times so as to cater to the high transportation cost of the state.
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