Customer Service or Cost? Optimization of the Supply Chain Design

In several articles I talked about competing objectives to the classical cost reduction goals (eg. with responsiveness or with reducing uncertainty).

Shen and Daskin (2005) explore the “Trade-offs Between Customer Service and Cost in Integrated Supply Chain Design”. The goal is to find ways to simultaneously improve customer service and reduce operating cost.

Modell

The authors model a three tier supply chain, with a supplier, distribution center, and retailer.
The following cost factors are considered: Facility Location, Inventory, divided into working inventory and safety stock, and distribution cost.
Since the goal is to find design decisions which lead to reduced cost and improved service the customer service is measured by the fraction of all demands that are within a specific distance to the distribution center. To make the cost and service requirements comparable Shen and Daskin have to introduce a weighing factor, in this case for the uncovered demand. In practice this factor represents the cost equivalent of any unmet demand, including lost sales, but also effects of negative reputation due to bad service, etc.

Solution

Shen and Daskin use an genetic algorithm to solve the network design problem. A genetic algorithm uses several concepts which follow the genetic selection metaphor. Operators in genetic algorithms are, for example: preservation of elites, mutations and expansions. Using this they reach optimal or near optimal solutions.

Management Insight

The authors gain two major insights from their experiments:

• The cost difference between the cost-minimization solution and the service-maximization solution can be quite large.
• Significant improvements in customer service can often be achieved at relatively little cost.

Conclusion

Shen and Daskin found the trade-off they promised in the title. At least for most parts of such a trade-off curve it is impossible to make service improvements without adding cost. Even though the insights somehow follow general intuition of increasing marginal cost for any trade-off, it stands as an important finding.
But as usual with modelling, it is important what factors you consider and which you leave out. There very likely could be positive effects on costs if the customer reaction to varying service levels had been considered.

You also already realized that the service measure used is probably not perfect as well. Most companies I talked to are using a more dimensional measure, which includes the fact that also customers out of a specific range can still be serviced.

Furthermore the authors could have used specific methods for calculating the weights of the service consideration (eg. using AHP, analyzed here).