68 Designing Distribution Networks and Applications to e- business learning objectives after reading this chapter, you will be able to

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Designing Distribution Networks and Applications to e- Business


After reading this chapter, you will be able to:

  1. Identify the key factors to be considered when designing a distribution network.

  2. Discuss the strengths and weaknesses of various distribution options.

  3. Understand how e-business has affected the design of distribution networks in different industries.

In this chapter, we provide an understanding of the role of distribution within a supply chain and identify factors that should be considered when designing a distribution network. We identify several potential designs for distribution networks and evaluate the strengths and weaknesses of each option. We apply these ideas to discuss the evolution of distribution networks in various industries since the advent of e-business. Our goal is to provide managers with a logical framework for selecting the appropriate distribution network given product, competitive, and market characteristics.


Distribution refers to the steps taken to move and store a product from the supplier stage to a customer stage in the sup­ply chain. Distribution occurs between every pair of stages in the supply chain. Raw materials and components are moved from suppliers to manufacturers, whereas finished products are moved from the manufacturer to the end con­sumer. Distribution is a key driver of the overall profitability of a firm because it affects both the supply chain cost and the customer experience directly. Distribution-related costs make up about 10.5 percent of the U.S. economy and about 20 percent of the cost of manufacturing. For commodity products, distribution forms an even higher fraction of the product cost. In India, the outbound distribution cost of cement is about 30 percent of the cost of producing and selling cement.

It would be no exaggeration to state that two of the world's most profitable companies, Wal-Mart and Seven­ Eleven Japan, have built the success of their entire business around outstanding distribution design and operation. In the case of Wal-Mart, distribution allows the company to provide high availability levels of relatively common products at a very low cost. In the case of Seven-Eleven Japan, effective distribution provides avery high level of customer responsiveness at a reasonable cost.

The appropriate distribution network can be used to achieve a variety of supply chain objectives ranging from low cost to high responsiveness. As a result, companies in the same industry often select very different distribution networks. Next, we discuss industry examples that highlight the variety of distribution network choices and the issues that arise when selecting among these options.

Chapter 4 • Designing Distribution Networks and Applications to e-Business 69

Until 2007, Dell distributed its PCs directly to end consumers, whereas companies such as HP distributed through resellers. Dell customers waited several days to get a PC, whereas customers could walk away with an HP PC from a reseller. Starting in June 2007, Dell also started selling its PCs through retailers such as Wal-Mart. Gateway opened Gateway Country stores, where customers could examine the products and have salespeople help them configure a PC that suited their needs. Gateway, however, chose to sell no products at the stores; all PCs were shipped directly from the factory to the customer. By April 2004, Gateway closed all its stores because of their poor financial performance. Apple Computer, in contrast, has opened many retail stores where computers are sold. These PC companies have chosen different distribution models. How can we evaluate this wide range of distribution choices? Which ones serve the companies and their customers better?

P&G has chosen to distribute directly to large supermarket chains while obligating smaller players to buy P&G products from distributors. Products move directly from P&G to the larger chains, but move through an additional stage when going to smaller supermarkets. Texas Instruments, which once used only direct sales, now sells about 30 percent of its volume to 98 percent of its customers through distributors, while serving the remaining 2 percent of customers with 70 percent of the volume directly. 1 What value do these distributors provide? When should a distribution network include an additional stage such as a distributor? Proponents of e-business had predicted the death of intermediaries such as distributors. Why were they proved wrong in many industries? Distributors playa much more significant role for consumer goods distribution in a coun­try such as India compared to the United States. Why might this be the case?

W.W. Grainger stocks about 200,000 SKUs that can be sent to customers within a day of order placement. The remaining slower-moving products are not stocked but instead are shipped directly from the manufacturer when a customer places an order. It takes several days for the customer to receive the product in this case. Are these distribution choices appropriate? How can they be justified?

As the preceding examples illustrate, firms can make many different choices when designing their distribution network. A poor distribution network can hurt the level of service that customers receive while increasing the cost. An inappropriate network can have a significant negative effect on the profitability of the firm, as evident in the failure of many business-to-consumer (B2C) companies such as Webvan. The appropriate choice of distribution network results in customer needs being satisfied at the lowest possible cost.

In the next section, we identify performance measures that need to be considered when designing the distribution network.


At the highest level, performance of a distribution network should be evaluated along two dimensions:

  1. Customer needs that are met

  2. Cost of meeting customer needs

Thus, a firm must evaluate the impact on customer service and cost as it compares different distribution network options. The customer needs that are met influence the company's revenues, which along with cost decide the profitability of the delivery network.

Although customer service consists of many components, we focus on those measures that

are influenced by the structure of the distribution network. These include:

1 A Tale of Two Electronic Component Distributors, Ananth Raman and Bharat P. Rao. Harvard Business School Case 9-697-064. 1997.

70 Part II • Designing the Supply Chain Network

  • Customer experience

  • Time to market

  • Order visibility

  • Returnability

Response time is the amount of time it takes for a customer to receive an order. Product variety is the number of different products/configurations that are offered by the distribution network. Product availability is the probability of having a product in stock when a customer order arrives. Customer experience includes the ease with which customers can place and receive orders as well as the extent to which this experience is customized. It also includes purely experiential aspects, such as the possibility of getting a cup of coffee and the value that the sales staff provides. Time to market is the time it takes to bring a new product to the market. Order visibility is the ability of customers to track their orders from placement to delivery. Returnability is the ease with which a customer can return unsatisfactory merchandise and the ability of the network to handle such returns.

It may seem at first that a customer always wants the highest level of performance along all these dimensions. In practice, however, this is not the case. Customers ordering a book at Amazon.com are willing to wait longer than those who drive to a nearby Borders store to get the same book. In contrast, customers can find a much larger variety of books at Amazon compared to the Borders store. Thus, Amazon customers trade off fast response times for high levels of variety.

Firms that target customers who can tolerate a long response time require only a few loca­tions that may be far from the customer. These companies can focus on increasing the capacity of each location. In contrast, firms that target customers who value short response times need to locate facilities close to them. These firms must have many facilities, each with a low capacity. Thus, a decrease in the response time customers desire increases the number of facilities required in the network, as shown in Figure 4-1. For example, Borders provides its customers with books on the same day but requires hundreds of stores to achieve this goal for most of the United States. Amazon, in contrast, takes about a week to deliver a book to its U.S. customers, but uses only about eight locations to store its books.

Changing the distribution network design affects the following supply chain costs (notice that these are four of the six supply chain drivers we discussed earlier):

  • Inventories

  • Transportation

  • Facilities and handling

  • Information

Chapter 4 • Designing Distribution Networks and Applications to e-Business 71

The other two drivers, sourcing and pricing, also affect the choice of the distribution system; the link will be discussed when relevant. As the number of facilities in a supply chain increases, the inventory and resulting inventory costs also increase (see Chapter 11), as shown in Figure 4-2.

To decrease inventory costs. firms try to consolidate and limit the number of facilities in their supply chain network. For example, with fewer facilities, Amazon is able to turn its inventory about 12 times a year, whereas Borders, with about 400 facilities, achieves only about two turns per year.

Inbound transportation costs are the costs incurred in bringing material into a facility.

Outbound transportation costs are the costs of sending material out of a facility. Outbound trans­portation costs per unit tend to be higher than inbound costs because inbound lot sizes are typically larger. For example, the Amazon warehouse receives full truckload shipments of books on the inbound side, but ships out small packages with only a few books per customer on the outbound side. Increasing the number of warehouse locations decreases the average outbound distance to the customer and makes outbound transportation distance a smaller fraction of the total distance traveled by the product. Thus, as long as inbound transportation economies of scale are maintained, increasing the number of facilities decreases total transportation cost, as shown in Figure 4-3. If the number of facilities is increased to a point where inbound lot sizes are also very small and result in a significant loss of economies of scale in inbound transportation, increasing the number of facilities increases total transportation cost, as shown in Figure 4-3.

72 Part II • Designing the Supply Chain Network

Facility costs decrease as the number of facilities is reduced, as shown in Figure 4-4, because a consolidation of facilities allows a firm to exploit economies of scale.

Total logistics costs are the sum of inventory, transportation, and facility costs for a supply chain network. As the number of facilities increases, total logistics costs first decrease and then increase as shown in Figure 4-5. Each firm should have at least the number of facilities that minimize total logistics costs. For example, Amazon has more than one warehouse primarily to reduce its logistics costs (and improve response time). As a firm wants to reduce the response time to its customers further, it may have to increase the number of facilities beyond the point that minimizes logistics costs. A firm should add facilities beyond the cost-minimizing point only if managers are confident that the increase in revenues because of better responsiveness is greater than the increase in costs because of the additional facilities.

The customer service and cost components listed earlier are the primary measures used to evaluate different delivery network designs. In general, no distribution network will outperform others along all dimensions. Thus, it is important to ensure that the strengths of the distribution network fit with the strategic position of the firm.

Chapter 4 • Designing Distribution Networks and Applications to e-Business 73

In the next section, we discuss various distribution networks and their relative strengths and weaknesses.

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