Designing a facility decisions approach

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Designing a facility decisions approach

Based on Analytical Hierarchy Process

Lisanne de Bie

Master thesis

Technology Management

December 2009

Company:

Sonepar Asia, Hong Kong

University of Groningen

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Preface

This report is the thesis to finalize my study Master of Science Technology Management at the Rijks Universiteit Groningen. I got the opportunity to write this thesis in Hong Kong S.A.R. under supervision of Sonepar Asia Pacific through an internship. This internship was focused on finding a new warehouse facility for the operations of Sonepar in Hong Kong and this subject was therefore the foundation of my research.

There are many people, who have supported me throughout this research, and I would like to start by thanking the team of Sonepar Asia Pacific. Marius van Huijstee, Matthieu Raffestin, Carmen Ho and Fenting Huang have taken the time to make me understand the fundamental business of Sonepar and give me new insights on the Hong Kong market. I also got the opportunity to visit one of the Sonepar branches in Shanghai and receive a 4 day training based on logistic operations in Asia to increase my knowledge on the subject; this was made possible through Paul McLachlan, product management manager of Hagemeyer China. Special thanks to the operational managers of the Sonepar branches in Hong Kong, Michelle Chan and Albert Poon, who gave me all the information I requested and helped me to be able to identify important elements within the operations. Also thanks to Sonepar logistic experts Patrick Verhougstraete and Tim Dietz, of Sonepar Belgium and Germany, for sharing their knowledge and expertise with me.

From the University I would like to specially thank Dr L. Zhang, she has been a great support and supervisor throughout this whole project, even with the big time difference that would sometimes interfere with communication appointments. And of course my second supervisor, A. Ittoo, specially for his insights in Information Systems.

Enjoy reading this research and hopefully it will give you a better understanding about warehouse facility decisions.

Lisanne de Bie

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Abstract

The focus on customer service is a new trend in logistic operations and cost objectives are no longer only the key considerations for logistic decisions. The main objectives within facility decisions nowadays are to minimize cost and optimize customer service. Reaching these objectives will increase the

sustainable advantage of a company in the current business environment and Sonepar Asia Pacific wants to examine how they can reach this for their operations in Hong Kong.

The level of customer service of a company in logistics is determined by the business logistic strategy. Business logistics contains three strategies, namely; transportation, inventory and location. Elements of these three strategies together determine the facility decision, however, the specific elements of these strategies that influence facility decisions have not yet been determined. Therefore the research question of this thesis is:

What elements of the three business logistic strategies are of influence in a warehouse facility problem that aims for cost minimization and customer service?

The answer to this question will be a list of criteria derived from the three strategies that need to be considered within a facility decision. This can then be used to reach the objective of this research for the Sonepar operations within Hong Kong;

To determine a new warehouse facility that meets the goals of cost minimization and customer service. The problem addressed within this research is to design an approach that incorporates both objectives. Extant literature on facility decisions focus either cost minimization or customer service levels. Because the current business environment forces companies to focus on both objectives, the methods presented in current literature do not cover all relevant issues. Also, facility decisions discussed in literature are mainly discussed as a decision that is only concerned with location elements and disregards other important elements that are part of a business logistic strategy.

The approach presented in this thesis incorporates both objectives through the combination of two analyses and is therefore a new approach to facility problems. The first analysis of the approach

represents the customer service objective. This is a multi-attribute decision and is therefore approached through the Analytical Hierarchy Process (AHP). The AHP is based on a set of criteria that first need to be identified as relevant for the problem situation. These criteria were derived from a theoretical research. This research was aimed to determine the relative elements of customer service requirements for a warehouse facility problem that are part of a business logistic strategy.

The research will contain two parts; the first part will be a theoretical research and will discuss the importance of customer value and customer service and will define the elements of business logistics significant in creating customer value. At the end of the first part a list of criteria that need to be considered in facility problems will be established through the Analytical Hierarchy Process.

The second part will provide a real-life case example to validate the new warehouse facility decision approach based on AHP and a cost analyses. The criteria defined in the first part of the research will be translated into the requirements of Sonepar in the Hong Kong market. With the use of these

3 The first part concluded that the main customer service requirements in terms of logistics are to enable a large assortment of products available and that the distance between customer and warehouse is small enough so that the order can be delivered fast, on time and complete. This means logistic service providers need to be focusing on availability, reliability and flexibility. These three objectives combined with low cost are the main points of focus for a warehouse facility. At the end of part one of this research the hierarchy of criteria that would lead to obtaining these four objectives is established. There were fifteen criteria identified through theory and expert knowledge that were used in the second part of this research. These criteria ranged from low rental price to facility features such as rectangular shape and ceiling heights. Also parking facilities for delivery trucks and distance to major traffic

intersections were taken into account. These criteria were used to score the alternative facilities. Five alternative warehouse facilities within the Hong Kong region that met the constraint requirements of maximum rental fees and surface area available were ranked through the AHP on the identified criteria. Also a cost analyses based on rental cost, management fees, expected extra investments and savings was conducted. This resulted in the BBC warehouse in Fanling to be the best option for a new warehouse facility for the Sonepar operations in Hong Kong.

BBC warehouse in Fanling has the best scores in both the AHP and cost analyses and is therefore placed first in the final ranking. The BBC warehouse has the following features that contributed to this score; the warehouse is located at a place that can reach every customer in the applicable region within a couple of hours and therefore meets the requirements set by the customer of 1 day delivery. The surface area is large enough so that the assortment in stock is able to fulfill needs related to product availability. Outside the warehouse has a large parking area that enables the trucks from the suppliers to unload the products quick and efficient as well as the trucks that pick up the orders for delivery to the customer. Also, the warehouse is located at a decent distance from all major traffic intersections of harbor, railway and highway to increase delivery speed and convenience for suppliers that drop products off at the warehouse. The warehouse also scores on criteria derived from inventory strategy because the warehouse is located all on one floor and has a rectangular shape. This will increase the possibilities to work efficient inside the warehouse facility and eliminates the requirement for cargo lifts. All together this warehouse is the best option for a new facility according to the AHP calculations of all the alternatives.

This also means that it is a better alternative than the current situation. The warehouse in Fanling has the highest scores on both analyses and can therefore be a good warehouse facility given all the criteria that are important. This location has the features that enable the creation of customer value through customer service in a cost efficient way. This means that it fulfills both objectives that were identified as important in the beginning, namely; minimization of cost and creation of customer value through a new warehouse facility.

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Table of Contents

1.2 The case company: Sonepar Hong Kong ... 12

1.3 Research objective and question ... 13

1.3.1 Research objective ... 13 1.3.2 Research question ... 13 1.3.3 Report overview ... 14 2 Research design ... 16 2.1 Conceptual model ... 16 2.2 Research scope ... 17 2.3 Research methodology ... 18 2.3.1 Choice of methodology ... 18 2.3.2 Desk research ... 19 2.3.3 Field research ... 19 3 Theoretical foundations ... 20 3.1 Customer value ... 20

3.1.1 Customer value in logistics ... 21

3.1.2 Customer value creation ... 21

3.1.3 Customer service ... 23

3.1.4 The marketing mix ... 24

3.1.5 Customer needs ... 25

3.2 Logistics ... 27

3.2.1 Location strategy and its impact on warehouse facility problems. ... 27

3.2.2 Inventory strategy and its impact on warehouse facility problems. ... 28

3.2.3 Transportation strategy and its impact on warehouse facility problems. ... 29

3.2.4 Planning levels ... 30

3.3 Relationship between warehouse facility decisions and customer service ... 30

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4 Approach development ... 36

4.1 Facility decision approach ... 36

4.2 Hierarchy building ... 37

4.2.1 Define goal and problem situation ... 37

4.2.2 Identification of alternative warehouse facilities ... 39

4.2.3 Identify criteria ... 45

4.3 Priority establishment ... 49

4.4 Calculation of the ratings ... 52

4.5 Alternative comparison ... 55

4.5.1 Alternative comparison based on AHP ... 55

4.5.2 Cost analysis ... 60

4.6 Choosing the best alternative ... 61

4.6.1 AHP outcomes ... 61

4.6.2 Cost analyses outcome ... 62

4.6.3 Choice of alternatives ... 62

5 Conclusion ... 64

6 Further discussion and research ... 68

6.1 Limitations ... 68 6.2 Further research ... 68 6.2.1 Transportation strategy ... 68 6.2.2 Inventory strategy ... 69 7 References ... 73 8 Appendix... 77

8.1 Current situation details ... 77

8.2 Warehouse facility alternatives... 86

8.3 AHP calculations ... 93

8.4 Information Systems ... 101

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List of Figures

Figure 2: Report overview ... 15

Figure 3: Conceptual model ... 16

Figure 4: Relationship between marketing and logistics (Langley and Holcomb, 1992) ... 24

Figure 5: Warehouse design problem categories (adapted from Gu et al, 2005) ... 28

Figure 6: Analytic Hierarchy Process phases (Saaty, 1980) ... 33

Figure 7: Facility decision approach ... 36

Figure 8: Locations current operations Supermoon and Tai Po Electric ... 38

Figure 9: Surface area overview ... 40

Figure 10: Surface area split ... 40

Figure 11: Location warehouse alternatives ... 42

Figure 12: Criteria overview for facility decisions for Sonepar ... 48

Figure 13: Criteria overview with priority vector ... 54

Figure 14: Warehouse process flow (derived from Coyle et al, 2009) ... 70

Figure 15: IT investment results (Drickhamer, 2006) ... 71

Figure 16: Total order deliveries ... 78

Figure 17: Supermoon order deliveries ... 79

Figure 18: Tai Po order deliveries ... 79

Figure 19: Overview supplier locations ... 81

Figure 20: Locations current operations Supermoon and Tai Po Electric ... 82

Figure 21: Warehouse process flow (derived from Coyle et al, 2009) ... 103

Figure 22: ERP integrated architecture (Rizzi and Zamboni, 1999) ... 105

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List of Tables

Table 2: Most important variables of the marketing mix components (Adapted from Lambert and Harrington, 1989) ... 25

Table 3: Factors explaining the underlying structure of the variables in the marketing mix (Adapted from Lambert and Harrington, 1989) ... 26

Table 4: Transportation modes (adapted from bron opzoeken) ... 29

Table 5: Example logistics planning levels ... 30

Table 6: Value of relative importance ... 34

Table 7: Facility decision elements according to theory ... 35

Table 8: Warehouse operation summary ... 38

Table 9: Overview of warehouse operations ... Error! Bookmark not defined. Table 10: Overview required surface area ... 41

Table 11: Overview criteria weight ... 49

Table 12: Overview relative importance value ... 50

Table 13: Relative importance per criteria ... 51

Table 14: Standardized scores and priority vector per criteria ... 53

Table 15: Warehouse criteria scores ... 56

Table 16: Alternatives scores per criteria... 57

Table 17: Priority vector calculation per criterion ... 58

Table 18: Final score calculation low cost ... 58

Table 19: Final score overview ... 59

Table 20: Warehouse alternatives score overview ... 59

Table 21: Rent overview ... 60

Table 22: Cost overview warehouse alternatives ... 61

Table 23: Cost analyses overview... 62

Table 24: Calculation final ranking facility alternatives ... 63

Table 25: Final ranking facility alternatives ... 63

Table 26: AHP criteria in a facility problem ... 66

Table 27: Current warehouse cost ... 83

Table 28: Summary warehouse ... 84

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1 Introduction

1.1 Background

Traditionally the main functions of a warehouse are to receive, store and ship goods to the customer. For a long time executing only these functions was enough to remain competitive in the market and a warehouse was only considered to be four walls that enabled the product to move from the

manufacturer to the customer. In order to create economies of scale, large facilities that would cover the distribution for big areas and the distance between the customer and the warehouse were large (Hurdock, 2000). The warehouse location was not an issue to be considered for a long time.

Nowadays facility location is considered to be a key element in a supply chain and the decision about this facility is a critical element in strategic logistic planning. The recognition of the importance of a warehouse location is mainly driven by the changing business environment. (Woodruff, 2008)

The current business environment is characterized by growing customer demands, global competition and slow-growth economies. For the last decades the internal operation processes and structure was the centre of attention. Quality management became popular. Nowadays, product innovation and quality management no longer provide the basis for a competitive edge (Butz and Goodstein, 1996). This raises the need of many companies to find new ways to position themselves in order to retain and increase their competitive advantage (Woodruff, 2008). While companies keep improving the internal quality, the external market based pressures keep increasing. Customers are not only looking for a company that provides the product they require, but also for extra services and a company that will go the extra mile in order to please the customer. These kinds of services can range from giving

professional advice before the purchase to installing the product for the customer. This highlights the need for companies to focus on both their internal operations and the external customer wishes in order to remain competitive. (Woodruff, 2008). One way to focus on both internal and external factors is to pay attention to customer value.

One way to do this is by paying more attention towards customer value. Customer value is defined as the difference between the realization or the product or service acquisition and sacrifice for the customer to obtain the product or service (Business Glossary, 2005).

Customer values can be translated into strategic objectives by setting customer service goals that are aligned to the core values of the companies’ customers. Customer service is defined by La Londe, Cooper and Noordewier (1988) as a process which takes place between a buyer, a seller and a third party. The process results in added value to the product or service exchanged. This added value in the exchange process might be short term in a single transaction or might span over longer term as in a contractual relationship. Value added is also shared, in that each of the parties of the transaction or contract is better off at the completion of the transaction than it was before the transaction took place. Thus, in a process view: customer service is a process for providing significant value-added benefits to the supply chain in a cost effective way and a warehouse facility can be used to provide this customer value.

10 important that a warehouse is located in a place that enables this service. Location of a warehouse is a critical issue that will strongly influence the ability of a company to provide the customer with required service or product through logistic operations.

Besides location there are other factors that can create value. These are related to the “seven R’s of logistics”, which states that logistics is ensuring the availability of the right product, in the right quantity and the right condition, at the right place, at the right time, for the right customer at the right cost. (Shapiro et al, 1985). The customer requirements determine what is defined by “right”.

Based on the discussion above, logistics is not restricted to place utility and the location strategy. Other factors that are implied in the definition such as the time of delivery, the condition of the product and the price also play a significant role in logistics. This means that also the transportation and order accuracy need to be in line with customer requirements to add value. The way a company handles their transportation and orders are determined by respectively the transportation and inventory strategy. Ballou (1998) describes this relationship in his logistic planning triangle that is shown in Figure 1. Transportation, inventory and location strategies will, among others, set inventory levels, decide modes of transport and determine the number, size and location of facilities in order to reach the customer service goals level considered necessary by the company. This triangle will be further discussed in chapter 3.

Customer Service Goals

Inventory Strategy Transportation

Strategy

Location Strategy Logistics planning triangle

Figure 1: Logistic planning triangle (adapted from Ballou, 1998)

11 point of use or consumption in order to meet customer requirements. The warehouse facility fall under location strategy and this is often the starting point of designing a business logistic strategy. This is because it is, generally, out of the three strategies; location strategy is the one that will define the operations in the longest time.

According to Current et al (1990) decisions on warehouse facilities are often based on location strategy and driven by the criteria of cost minimization with respect to rental cost. Important cost criteria that can be identified are to minimize the number of facilities or to move to a location that has lower rental fees. Another main criterion is based on demand orientation. The location of warehouse determines the markets that can be served and service levels that can be accomplished and offered to the customer (Jukka Korpela & Markku Tuominen). These two criteria have interdependence as can be seen. If a company’s warehouse is unable to serve its intended region, the company should consider that adding extra warehouse facilities will undoubtedly result in an increase in cost.

To detemine a business logistic strategy the first step is to define the location strategy of a company, which also included the choice of a warehouse facility. After this is set, deciding on transportation and inventory strategy will be the next step. A combination of an internal focus on cost and an external focus on customer needs are the key elements for a location strategy in the current market to create logistic value. But the influence of location on the other two elements of business logistics (transportation and inventory) also needs to be taken into account.

Literature mentions various approaches to help managers make decisions regarding warehouse facility location. The research approaches suggested for solving facility location problems in literature can be categorized in two streams (Thai & Grewal, 2005). The first one is based on cost and quantitative variables models. One example of a common approach in the first category is the Simple Plan Location Problem (SPLP). Prior works of Uster etc al (1983) and Sharma & Muralidhar (2009) discussed SPLP. This method aims to choose a minimum number of plants with unlimited capacities so that a given number of markets (each with a known demand) can be serviced while minimizing the sum of fixed costs of plant location and the transportation costs of shipping goods from plants to markets (Sharma & Muralidhar, 2009).

The first category contains methods that do not consider the qualitative variables. This is also seen by many as the biggest shortcoming of this category. MacCormack et al (1994) argues that decisions of location that are solely based on quantitative criteria, such as labor cost and transportation cost, are less suitable. Because qualitative factors are more likely to provide long term advantages and the

importance these factors are underestimated.

The second category suggests the use of methods that do incorporate qualitative elements into location decisions. Yoon and Hwang (1985) recognize the importance of the qualitative elements in their

research. They use the Multiple Attribute Decision Making (MADM) method as their approach. Although they identify qualitative elements to be of significant importance, elements that aim to provide

customer service are not included in their research. Alberto (2000) does incorporate logistic service-related considerations into the decision model. Time reliability, response flexibility and capability of operations’ integration with customers are included in his work, but he does not link the influence of the three different strategies within business logistics to the choices of elements in his research.

12 importance of taking into account the other strategies related to business logistics in order to define the considerations within a location decision model have not been addressed in any of these researches. In this thesis a methodology for facility decisions will be proposed that will consider both qualitative and quantitative elements. The traditional considerations based on cost minimization and logistic service-related elements will be indicated and included to the decision model. The final list of considerations will include all criteria important to a warehouse location with respect to the total business logistic view. This means taking into account elements that are derived from transportation and inventory strategy. The presented approach will be used on a case study of a company that considers relocation of the current warehouse. The case study will illustrate how qualitative criteria can be used to reach a good decision in a location problem and how to define these intangible elements into useful criteria.

1.2 The case company: Sonepar Hong Kong

This research will be conducted under the supervision of Sonepar Asia Pacific in Hong Kong. This paragraph will introduce the company and the problem that they face at the moment.

Company

Sonepar is a global player in electrical material distribution. The company that is of French origin is nowadays active in over 34 countries over the whole world. Since 2000, Sonepar has made further investments in Asia (Hong Kong) and Latin America (Mexico, Brazil and Argentina). One of the strategic levers of the company also is:

Vastly expanded scope in Asia and Oceania, with pro forma turnover of more than €600 million in 2007 and the resources needed to deploy an aggressive strategy in high-growth markets. For reaching this goal, Sonepar purchased Hagemeyer’s operations in North America, the Asia region and Oceania. Sonepar has acquired several different companies within the Hong Kong market today. At this moment Tai Po Electric and Supermoon Holding Ltd are part of the Sonepar group. They have been running total separate operations so far and Sonepar wants to start with the combining of back office operations for these two companies. This is relevant at the moment because of the growing market pressure to increase internal efficiency simultaneous with increasing customer service in order to meet customer needs. The difference between the companies in terms of operation strategies and company culture underscore the importance for Sonepar to integrate back office operations, align strategies and promote business between the companies in the Sonepar group, this will then lead to a more successful way of running the business. The increase of efficiency of the business logistics through back office integration cannot influence the customer service provided at the moment in a negative way. Sonepar is a

distributor that provides logistic services to their customers and the warehouse is the link between Sonepars’ customers and the products they buy from their suppliers. Sonepar enables customers to have one stop to gather a wide variety of products.

Market strategy

13 This strategy can be defined as a combination of the value disciplines of operational excellence and customer service. This will be further explained in chapter 3. With this strategy Sonepar wants to increase their market share and create a sustainable competitive advantage.

1.3 Research objective and question

This paragraph will define the research objective with respect to Sonepar and research question and sub questions necessary to reach the objective of the thesis.

Sonepar wants to start to combine the back office operations of the companies in Hong Kong. This research will look at the first step of a new warehouse facility to optimize the business logistics of the total operations and remain the same customer service level for Hong Kong.

The main matter in this research is how Sonepar can redesign their warehouse, while maintaining or enlarging customer value. They want to do this by setting up one central warehouse for all the companies in Hong Kong together.

1.3.1 Research objective

Based on the information above, the issue between meeting customers’ requirements by setting customer service goals and having a suitable location strategy is an important one for Sonepar. The research objective of this thesis is defined as follows:

To determine a new warehouse facility that meets the goals of cost minimization and customer service. This will be done by indentifying multiple alternatives. The most suitable option will be determined through detailed analyses of both theory and a case example. These analyses will identify benefits in terms of cost en efficiency. The alternative that has the best outcome will be the most suitable option.

1.3.2 Research question

In order to meet the research objective stated it is important to understand the different areas within both business logistics and customer service and know how they influence one another. Therefore the research question of this thesis will be:

What elements of the three business logistic strategies are of influence in a warehouse facility problem that aims for cost minimization and customer service?

The answer of this research question will be presented at the end of the theoretical part of this research. In order to reach this answer, multiple sub problems will be discussed with the help of smaller sub questions.

The sub questions for this research are defined as follows: • What is the role of facility in the business logistics?

• What areas need to be considered in the tradeoff between business logistics cost and customer service?

• What are the criteria concerning facility decisions that are suitable for the operations of Sonepar Hong Kong?

14 1.3.3 Report overview

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2 Research design

The research design is an overview of the steps necessary in order to obtain the answers to the research question. First the conceptual model will be presented and discussed in order to identify what needs to be analyzed further on. After this an overview of the chapters of this research and the contents will be defined.

2.1 Conceptual model

It is important to understand the different elements that are involved in making a good warehouse facility decision. In the introduction the place of facility decisions is described as being part of a location strategy and the main considerations identified in facility decisions are cost minimization and customer service levels. These considerations are influenced by the trade off a company makes within the logistic planning triangle of Ballou (1998). This means that on one side the location strategy is influenced by the other two strategies within business logistics, namely; transportation and inventory. On the other side it is influenced by customer service requirements. The conceptual model in Figure 3 is shows the elements that are of influence of defining a location strategy to make a facility decision. The elements are based on the factors identified in chapter 1. Facility decisions are part of a location strategy, and this strategy is influenced by more elements that shown and discussed in the conceptual model. But these fall outside the scope of this research and are therefore not included.

Customer Service Customer Value Customer Needs Conceptual Model Location strategy Cost Minimization Inventory Strategy Transportation Strategy

Facility decision

17 This section will briefly discuss the elements shown in the conceptual model en the relationship between them.

Facility decision: A facility decision is part of the location strategy and therefore placed within the location strategy box. Because it is part of the location strategy it is influenced by the same elements as this strategy (see below).

Location Strategy: The main objective of identifying a new warehouse facility falls under location strategy. Location strategy is the key aspect of a distribution company. Defining the number of facilities and exact locations and facilities is crucial for the operations. The main drivers for location strategy are customer service and cost minimization. It is important to have strategy that fulfills these two elements in the best way possible. On the other side is location strategy part of a total business logistic strategy that also contains inventory and transportation strategy. These interdependencies will also be analyzed further on in the research.

Customer value: Customer value is, among other things, influenced by customer needs from one side and customer service goals set by the company on the other side. When the customer’s demands change the value perceived by these customers will also be affected. This can either be a positive or a negative affect depending on the change in customer needs. On the other side customer value is influenced by the customer service goals set by the company to meet the identified customer needs. The extent to which these goals are met will influence the customer value. The more goals are accomplished the higher the value perceived by the customer will be.

Customer service goals: Customer service goals are influenced by the customer needs and the customer value. A shift in customer needs will directly affect the goals that need to be set by the company. The more demanding the customer is, the higher the goals should be set in order to retain customer value. It is also directly influenced by customer value. When customers adapt their perception of value the goals for customer service will have to change according to these shifts. Decisions for location strategy are highly influenced by the customer service goals set by the company.

Cost minimization: For a successful company it is not only important to operate in line with their customer’s needs. The cost minimization need be as large as possible. The cost considered in this research will only be the cost directly related to warehouse location. The important relationship displayed in the conceptual model is the one between customer service and cost minimization. The tradeoff between these two will be the central issue of this thesis. Not all strategies for improving cost minimization are in line with the customer service goals. For example, cost savings that will increase delivery times will have a negative effect on customer service goals if this is an important aspect for the customer. It is important to find a good fit between optimizing cost minimization and meeting customer service goals.

2.2 Research scope

The conceptual model shows the main elements of focus in this research, which is business logistics and customer value. This paragraph will specify the scope of this research and will list the basic research assumptions.

18 and intangible factors related to customer satisfaction. The factors can vary for every situation and are determined by the decision maker.

The problem situation can be defined as complex; this is because the final outcome depends on many different criteria that have a lot of interactions between them. These criteria can be characterized to be both quantitative and qualitative.

Decision makers faced with a location problem need to make numerous and conflicting evaluations of all the different factors and the interdependence between those factors. This kind of situations deal with factors that are influenced by subjectivity of the decision maker, the outcome is highly dependent on this and the definition of the goals and preferences (Badri, 1999). This means that the problem deals with both subjective and objective factors.

Alternatives for a location problem are not infinite. There is only a limited amount of facilities that will fit the basic requirements and will therefore be considered in the research.

The scope of this research will be:

• The elements and strategies analyzed must be appropriate for a distribution company. Element concerning the production and quality of a product will not be taken into account.

• The objective is a long term decision that will be made. This means that the aggregation level will focus on elements of strategic and tactical issues. Elements concerning day to day operations will fall outside of the scope of this thesis.

• The case study will only concern the customer and suppliers currently working with the Sonepar group in Hong Kong.

• The geographical scope of the case study will be the whole region that falls under the Special Administrative Region (SAR) Hong Kong.

2.3 Research methodology

The choice of methodology to use in order to reach the research objective must be based on the characteristics of the problem and the situation. The following paragraph will determine a suitable choice of methodology for the facility problem and will describe the methods used within this research.

2.3.1 Choice of methodology

Now that the basic research assumptions are made, is it time to look for methods that help in choosing the right methodology for the problem and will provide a clearer view of the situation and consistency of this paper.

As stated in section 2.2, this problem is characterized by making a decision based multiple criteria that have both a subjective and objective nature. Approaches for problems that have such characteristics fall within the field of multiple criteria decision making (MCDM).

19 (Zhang, 2001) namely; the problem can be approached without preference information, with

information on the attributes and finally with preference information on the alternatives. In case of the problem presented in this research preference information will be obtained on the attributes in order to rank the alternatives.

With the previous information taken into account, the Analytical Hierarchy Process (AHP) is suggested by literature to handle this kind of problem.

The Analytical Hierarchy Process: AHP is a method to structure a complex problem in the form of a simple hierarchy and to evaluate a large number of quantitative and qualitative factors in a systematic manner (Badri, 1999). AHP has been developed by Thomas Saaty (1980) and it is applied to problem situations that involve selecting one alternative out of a limited number of alternatives. The selection is made through ranking the different options with respect to one another. The decision maker will determine the weight of the various criteria by assigning different perceived degrees of preference or level of importance to the criteria involved in the process (Petkov, 2007).

A more detailed description of the AHP will be provided in chapter 3. To be able to develop the

hierarchy for this facility problem and to score the alternatives, a desk research and a field research will be conducted.

2.3.2 Desk research

In order to be able to identify a good set of criteria, a literature review is necessary to understand the different factors that need to be taken into account. For the theoretical foundations in this research, papers of academic magazines will be used together with literature found in academic books. The theoretical foundations will lead to a clear overview of what the elements in the conceptual model include and how they influence on another. Based on this information an accurate set of criteria and constrains will be developed to make a well founded warehouse facility decision.

2.3.3 Field research

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3 Theoretical foundations

This chapter will discuss the factors indicated in the conceptual model based on extant scientific literature. First the topics related to customer value will be discussed in paragraph 3.1. To understand the importance of customer value, the topic will be defined, related to logistics and ways to create customer value are described. This will lead to the next topic of customer service. The place of customer service and the customer needs that drive this factor will be defined. Paragraph 3.2 will focus on the different strategies that are included in setting up business logistics and will indicate how facility decisions are influenced by them.

The role of a warehouse facility in creating logistic customer service is a central issue in this thesis and therefore this chapter will conclude describing the relation between warehouse facility and the creation of customer service.

3.1 Customer value

In the current environment, a facility location problem cannot be based on cost minimization objectives alone as explained in the introduction. Nowadays warehouse facilities are used to create of customer value through logistic customer service, besides supporting the traditional warehouse functions of receiving, storing and shipping goods to the customer.

The service provided to the customer has to be at least at a level that creates customer value so that customers will actually buy the product or service provided by the company. This paragraph will discuss the concept of customer value. In the next paragraph we define the concept of customer value, highlight its importance, and illustrate how it is created.

Customer value definition

Customer value is defines as the difference between the realization and sacrifice for the customer (Business Glossary, 2005). Realization is the part that the customer receives. This includes everything that comes with the purchase, such as product features, quality, and service and takes into account the customer's cost to use, maintain, and dispose of the product or service. Sacrifice is what a customer gives up for the purchase, which includes the amount paid for the product, the time and effort spent to acquire the product and learning how to use the product.

Customer value is created when customer satisfaction is achieved (Langley and Holcomb, 1992).

Customer satisfaction in this paper is defined as: The degree to which products and services supplied by a company meet or surpass customer expectation (Langley and Holcomb, 1992).

The primary determinant of customer satisfaction of logistic service providers is the gap between customers' expectations of logistics service performance and actual logistics service performance (Sharma et al, 1995). This means that a company should know the customers’ expectations so that the service can match these in order to reduce the gap.

21 increases rapidly and vice versa if it drops below a certain level. This level varies per company but it shows the importance of maintaining a reasonable level to get a sustainable level of customer loyalty. Creating customer loyalty is critical to survival for a company for multiple reasons according to

Daugherty and Stank (1996). First of all, it is less expensive to resell to existing customers than to attract new buyers. Secondly, loyal customers are often less price sensitive because they are more brand-sensitive. This creates an opportunity for greater profit margins and decreases the chances for losing customers due to competitive price undercutting. Finally, repeat customers usually purchase larger volumes and varieties of products.

3.1.1 Customer value in logistics

Customer value of logistics is different from customer value of a product. This is because customer value of logistics has several unique characteristics, namely: (Langley & Holcomb, 1992)

1. Logistics is comprehensive. It crosses over company boundaries and is involved from the original source of raw materials until the final customer

2. Logistics is considered with both the flow of products and the flow of information. 3. Logistics provides viable opportunities to create value and satisfy customers.

In the past few years, managers have acknowledged the importance of logistics and started to dedicate more resources towards the logistic operations. An increase in strategic partnerships and a more “holistic” view is the result of this trend.

Many firms now believe that strategic logistic orientation is necessary to create customer value and a sustainable competitive advantage (Langley & Holcomb, 1992). This means that companies look, among other things, to create strategic partnerships with direct suppliers and customers in order to deal with the comprehensive character of logistics. Also there is more interest in the opportunities of value creation and customer satisfaction that are accomplished specifically through logistics.

3.1.2 Customer value creation

In order to create a sustainable competitive advantage, current theories suggest that a company should create customer value. Companies often focus on a value discipline to create customer value.

Value disciplines in logistics

Customer value can be created through the use of three value disciplines defined by Treacy and Wiersema (1993), namely; operational excellence, customer intimacy and product leadership.

Companies with leadership positions in the market usually master one or two of the three disciplines, while maintaining a reasonable performance level on the remaining ones.

22 Customer intimacy in logistics:

Customer intimacy as a value creation discipline is also referred to as the demand-oriented strategy. This discipline stresses the external customer, external customer boundaries, and external goals and objectives. It often embraces product or service differentiation and service enhancements from logistics capabilities such as time advantages, responsiveness to target markets or customer services.

Operational excellence in logistics:

This discipline is related to the operational capabilities and is referred to as a supply-oriented strategy. It emphasizes distribution networks for market value and for competitive advantage. Its benefits include high business performance due to product availability convenience and low total distribution cost. Customer intimacy focused more on the demand side and operational excellence is supply oriented. The two strategies (demand and supply oriented) and their associated capabilities that accompany these are listed in Table 1. Morash et al (1996) define capabilities as attributes, abilities, organizational processes, knowledge, and skills that allow a firm to achieve superior performance and sustained competitive advantage over competitors.

MAJOR STRATEGIC LOGISTICS CAPABILITIES AND THEIR DEFINITIONS Demand-Oriented Capabilities (D) Definitions

1 Pre-Sale Customer Service The ability to service the customer during the purchase decision process (i.e., before the customer buys the product).

2 Post-Sale Customer Service

The ability to service the customer after the sale of the product to ensure continuing customer

satisfaction.

3 Delivery Speed The ability to reduce the time between order taking and customer delivery to as close to zero as possible.

4 Delivery Reliability

The ability to exactly meet quoted or anticipated delivery dates and quantities

5 Responsiveness to Target Market(s)

The ability to respond to the needs and wants of the firm's target market(s).

Supply-Oriented Capabilities (S) 6 Widespread Distribution Coverage

(Availability)

The ability to effectively provide widespread and/or intensive distribution coverage. 7 Selective Distribution

Coverage

The ability to effectively target selective or exclusive distribution outlets.

8 Low Total Cost Distribution

The ability to minimize the total cost of distribution.

Table 1: Value disciplines in logistics and capabilities (Morash, 1996)

23 want to be superior in the market in the future. This means that they will try to achieve the optimal situation in balancing the creation of customer satisfaction and the internal business logistics. Morash et al (1993) also analyzed the important of the influence of logistic variables to achieve a sustainable advantage through customer satisfaction. They found out that variables such as delivery speed, reliability, responsiveness and low cost distribution had the highest co-relations with overall performance and therefore yield significant competitive advantage. It has to be taken into account that these four key logistic variables serve different objectives. Achievements on delivery speed,

responsiveness and reliability are important for growth in both sales and profit. On the other hand, low distribution cost will benefit operation performance and therefore margins. But all four are influenced by the warehouse location and are aimed to create customer value.

So, in summary, customer value is the perceived value of a product and or service by a customer. This is determined by the extent to which the product and or service satisfies the needs of this customer, referred to in this thesis as customer satisfaction. The more value is perceived by the customer, the more likely he is to continue buying the same brand and become loyal to the brand. This is often a goal for a company because loyal customers are more profitable than non-loyal customers in general. In logistics this means, among others, a company should have goals to have enough products in stock to be able to fill the orders, delivering the product on time at the right place at a good price. Also being flexible in delivery and provide guarantees for the products. A company can choose to pursue all these goals or focus on only a few to create customer value.

The creation of customer value in logistics can be established by fulfilling the customer’s expectations in terms of cost, speed, availability etc. It is important to understand the customer’s needs to be able to fulfill them through customer serivce. Often this is done through a strategy based on objectives of low cost, product availability and convenience, also referred to as operational excellence. Another option is a focus on customer intimacy; this strategy refers to creating a strong bond with the costumer and providing excellent service besides the sales of products. A combination of the two strategies is harder to achieve but also possible and there are examples of companies who have integrated the two successfully. The objectives within the two strategies, fulfill customer needs and cost minimization can be achieved through logistic operations in the three areas defined by Ballou (1998), namely;

transportation, inventory and location. This will be further discussed in paragraph 3.3.

3.1.3 Customer service

24 Figure 4: Relationship between marketing and logistics (Langley and Holcomb, 1992)

3.1.4 The marketing mix

The marketing mix is defined by Product, Price, Promotion and Place (referred to in Figure 4 as customer service); commonly referred to as 4P’s. It describes the strategy of a company in placing a product in the market. In terms of the four P’s this means that a marketer needs to provide a Product that the

customers want at a Price that the customer would find acceptable. The use of Promotion will indicate the advantages offered and it will be available at a Place that is desired by the customer (Yudelson, 1999). As can be seen, the customer is the main area of focus in the 4P strategy.

The 4P’s will be discussed more detailed below based on the definition given by Yudelson (1999). Product

Product should be defined as all the benefits (present or anticipated) that the buyer or acquirer obtains from the exchange with the supplier of the product or service. There are three levels of a product, namely: the core product, the actual product and the augmented product.

- The core product: this is the product as defined above, not only the tangible product but also all the benefits the product provides to the buyer or acquirer from the exchange.

- The actual product: this is the tangible item the customer purchases and can be defined in terms of brand, color, weight and amount.

- The augmented product: this is the intangible part. All elements that provide additional value to the customer besides the physical parts. Examples of augmented products include warranties and guarantees.

Price

Price should be defined as everything that the acquirer gives up to obtain the benefits. This acquisition does not only include monetary investments but also covers the circumstances in which the customer may give up something that is not gained by the seller or supplier. This happens for example in case of buying the “wrong brand” that can lead to social rejection, such as buying real fur clothes, because some people have a problem with wearing fur and will socially reject the person that buys this, and this is a significant part of the price that needs to be paid for certain benefits.

25 Promotion

Promotion is defined to include all of the information that is conveyed between the parties to the transaction. The purpose of this communication is to persuade or encourage a party to enter into a transaction through the providing of information to the potential customer about the cost and the benefits.

Place/customer service

Place can be defined as all that is done and required to facilitate or bring about the exchange. So it includes both the physical distribution to the shops and the delivery of the product after the purchase has been done. This distribution element in the marketing mix is the link to logistics. And the interface between the two areas is key to the delivery of customer service and the achievement of customer satisfaction (Lynch, 2007).

The marketing mix is used to create value through the four P’s in order to fulfill the customer needs. The following section will discuss the customer needs that drive the elements in the marketing mix.

3.1.5 Customer needs

To provide the right marketing mix to the customer it is important to first of all identify the customer’s needs, and secondly, align the company’s strategy with these needs.

Although customer needs vary per industry and even per customer it is possible to identify some variables that are important to consider in general. Lambert and Harrington (1989) did an intensive study to classify the weight customers give to certain variables to identify customer needs in various industries. The variables were categorized by the four elements of the marketing mix and a research was conducted to find the importance of these variables for the customer.

A total of 110 variables were identified through interviews divided over all four components of the marketing mix. Out of the 9 variables that were rated as most important in multiple industries, six related to customer service. One price, one promotion and one product variables make up the rest of the list. In all industries they examined the customer service variables count for the majority of the list. Table 2 shows the variables that were indicated by the industries as highly important.

Marketing Mix Component Common needs

Logistics/ Customer Service Ability to meet promised delivery date Accuracy in filling orders

Advance notice of shipping delays Action on customer service complaints Information on shipping date

Length of promised lead times for in stock products

Product Overall quality relative to price

Price Competitiveness of price

Promotion Prompt follow-up from sales force

26 Continuing this study, Lambert and Harrington (1989) tried to identify certain factors explaining the underlying structure of the variables in the marketing mix that were identified by the industry as being important. Table 3 displays the factors that overlapped in the industries per marketing element

Marketing mix component Underlying factor

Logistics/Customer service Information systems capability

Lead time

Product availability

Product Quality

Price Discount structure

Promotion Personal selling

Sales support

Table 3: Factors explaining the underlying structure of the variables in the marketing mix (Adapted from Lambert and Harrington, 1989)

From Table 3 can be concluded that the common needs indentified in Table 2 can be translated into underlying factors that influence the customer needs. For example, the lead time and product availability will determine, among other things, the ability to meet promised delivery dates. For a warehouse operation this means that the customer has three main needs for logistic operations: availability, flexibility and reliability. Products need to be available at any time the customer wants to order and they must be able to rely on the logistic service provider that delivery dates will be met and orders will be delivered complete and in good quality.

27

3.2 Logistics

The importance and the place of customer requirements have been discussed in paragraph 3.1. To provide the required customer service, logistic operations have to be aligned with these requirements to fulfill the customer needs. As discussed in section 1.1, the total logistic operations of a company are the business logistics and there are three strategies identified by Ballou (1988) within business logistics, namely;

• Location strategy • Transportation strategy • Inventory strategy

These three strategies influence one another significantly and therefore the impact of all three strategies on a facility decision will be considered

3.2.1 Location strategy and its impact on warehouse facility problems.

The establishment of a new warehouse is a decision that is associated with high cost and the acquisition of property. A new warehouse facility is therefore a long term investment that is critical in logistic

operations. Traditionally the location strategy had the goal to determine the optimal number of facilities, the correct size and good geographical location in order to minimize the total cost associated with these operations (Alberto, 2000). Nowadays there is growing focus on customer service objectives and can even be identified as one of the major logistic goals momentarily according to Langley & Holcomb (1992). This growing focus is driven by the increased importance of meeting customer requirements are

explained before. This means that besides the traditional goals other goals are added in developing a location strategy.

The following issues are part of a location strategy according to Alberto (2000) and Jayaraman (1992): Amount of facilities: The amount of facilities is influenced by multiple aspects. First of all the total area that needs to be covered through the warehouses will determine the number of facilities necessary. Secondly, the size of the warehouses’ surface area is of influence. A bigger warehouse will be able to cover a larger area to serve the customers.

Ownership: The company has to decide whether they want to rent a warehouse facility or buy their own premises.

Size: The size of the warehouse is determined by the number of facilities within the region and the necessary surface area to hold all the stock assigned to the warehouse.

Cost: Cost is one of the major considerations when it comes to location strategy. A new warehouse site means a potential for rent savings or a danger of rent increase or higher tax cost. Besides rental fees other cost can be required for a warehouse. Some facilities have management fees on top of rent for example.

28 Local incentives: Local incentives are also considered in location strategy. Factors like labor quality, labor cost, tax breaks and loans are regarded as extremely important. The goal of a company should be to find a location that will have the prospect of good labor management over a long period of time.

Location strategy is concerned with warehouse facilities and the issues of what, where, how many. Not only is the location determined in a location strategy but also the amount of distribution centers, the size of the distribution centers and the allocation of demand to the facilities. Location strategy is the core of business logistic strategy and a facility decision needs to incorporate all issues of the location strategy.

3.2.2 Inventory strategy and its impact on warehouse facility problems.

Strategic inventory decisions are concerned with warehouse operational planning. Among others, inventory management deals with the process of order fulfillment, inventory accuracy and cost efficiency. The strategy must structure the warehouse operations to fulfill the basic functions of a warehouse at an optimal level. Four basic warehouse functions are identified by Gu et al (2006) namely; 1) receiving, 2) storage, 3) order picking and 4) shipping. These functions are key to enabling the basic warehouse requirements of receiving Stock Keeping Units (SKUs), storing SKUs, receiving customer orders and order fulfilling by picking products and shipping orders to the customer. The warehouse should be designed that ensures its efficiency to dealing with these requirements. There are multiple problem areas classified by Gu et al (2005) concerning the warehouse design for an inventory strategy and Figure 5 shows these categories.

Figure 5: Warehouse design problem categories (adapted from Gu et al, 2005)

29 Warehouse sizing and dimensioning: this category deals with the storage capacity. Not only the size of the total warehouse is determined here, also the size of the different departments like racking, shelving and pick up area are part of this category.

Department layout: it is important to have an optimal layout for the warehouse to increase efficiency of the facility. In this category patterns for the pallet storage are determined among other things. Layout affects warehouse performance efficiency in multiple ways. Two of them are space utilization and storage capacity. The shape of the facility has a big influence on these performance ratings. The more the shape is similar to a square, the higher the space utilization is. The size of the premises needs to be large enough to fulfill the requirements set in this category.

If a company decides to either start a new warehouse or change location the size will be one of the main constraints in the search for a new facility. The shape of the warehouse is also of great importance for department layout. The shape was already mentioned above, but besides this other facility

characteristics are influencing the layout.

An ideal warehouse facility is “all on one floor” in a rectangular or square shape. High ceilings allow a warehouse to operate with racking systems that make efficient use of the surface are. If the facility has multiple floors facilities like cargo lifts need to be considered.

3.2.3 Transportation strategy and its impact on warehouse facility problems.

The transportation strategy in business logistics covers the decisions of the transportation from the warehouse to the customer. The goal of the strategy is to meet the customer requirement as in the most cost efficient manner. Customers require that their orders are delivered complete, at the exact time and date needed, in a good quality and complete. To meet these requirements, a transportation network has to be developed to minimize factors such as average travel time, distance between warehouse and customers, and transportation cost, and also it has to provide room for change

(Brandeau & Chiu, 1989). Finally the transportation needs to be able to deliver the goods in good quality. There are multiple areas that are considered during the development of such a transportation network. A key decision pertains to the transportation mode. There are multiple options for transportation mode, namely; air, rail, truck, water and pipeline. Table 4 gives an overview of the different transportation modes and lists some of their characteristics. Decisions regarding transportation mode are influenced by the location of both the warehouse and the customer.

Transport mode

Cost Volume Items

Door-to-door

Speed Flexibility

Air High Medium Lightweight,

small

No Fast High

Rail Low High Large items No Slow Medium

Truck Medium Small Medium and

lightweight

Yes Fast High

Water Low High Large heavy No Slow No

Pipeline High investment, low operational

High Oil products No Medium No

30 Besides the transportation mode the type of carrier is a key element. A company can decide to use a third party logistic partner (3PL) or in source transportation and handling it all by themselves. Another challenging issue is to determine which customers are served by which warehouse (This is only applicable in a situation with multiple warehouses).

As with inventory strategy, not all aspects of transportation apply to location strategy. For example the decision to in-source transportation or to hire a 3PL is not affected by the location of the warehouse. Transportation needs to be available and reliable (Korpela & Tuominen, 1996). Availability is influenced by the transportation mode and this is, among other things, influenced by the location. Not only the type of product will determine transportation mode but also the relation between distance and delivery times. When the distance between the warehouse and the customers is very large air transport is the only option if delivery times need to be fast. The transportation mode of suppliers to the warehouse also plays a role here. The warehouse location must facilitate the delivery of the product into the warehouse. This means having parking facilities if delivery is done by truck or access to railway, airport and/or harbor is this is necessary.

3.2.4 Planning levels

These three strategies all concern different topics of logistics and require different planning. There are three levels for decision making, the business planning levels (Schmidt and Wilhelm, 2000). The first, strategic, is concerned with long term issues, usually involving time spans of more than one year. The decisions on the company’s objectives, resource commitment such as money, time, and people in general is done at a strategic level.

The 2nd level, called tactical, deals with issues with a time span within one year and the implementation of the strategic level decisions. The last level, operational, deals with problems on an hourly or daily basis. The table below gives an example of the different areas of concern and the decisions that are made on the different level of planning.

Type Strategic Tactical Operational

Location Number of facilities, size, location, facility

Inventory positioning Routing

Transportation Mode Seasonal service mix Replenishment quantity and timing

Inventory Selecting order system Priority rules for customers

Speeding up orders

Table 5: Example logistics planning levels

As can be seen in Table 5 the decision of a new warehouse facility is on a strategic planning level. This level means a long term influence on the company.

31 and vice versa. Finally, the balance between the three strategies should be in line with the preferred level of customer service. This balance is depicted in the logistics planning triangle developed by Ballou (1998) that is shown in Figure 1 in the introduction.

As discussed in the introduction location decisions are nowadays based on both cost and customer service related criteria. The main customer service requirements in terms of logistics are to enable a large assortment of products available and that the distance between customer and warehouse is small enough so that the order can be delivered fast, on time and complete. This result in three main

customer needs that the company needs to meet; availability of products and reliability of order delivery and flexibility to deliver any at time. Strategies concerning transportation, inventory and location enable companies to meet these requirements. Location is the main point of focus in facility problems

according to theory. But a facility decision is also influenced by the other two strategies. Inventory strategy will determine the amount of stock and thus the assortment range that is provided by the company. Transportation is concerned with the delivery of the products in time.

The core of facility problem is the location as stated before. A facility decision needs to be based on criteria that enable the other two strategies to be most efficient. This means that facility decisions need to be based on the elements of the two other strategies that are influenced by the location.

The following elements of location, transportation and inventory strategy to provide customer service are influenced by facility according to theory:

Location:

- Amount of facilities - Rent or buy - Size

- Cost

- Region that needs to be served - Expanding possibilities

- Local incentives Transportation:

- Distance between warehouse location and customers

- Warehouse location with respect to distance to big traffic facilities such as harbor, railway and highway.

- Warehouse facilities to unload in load the products. Inventory:

- Warehouse capacity - Warehouse layout

32 for trucks to unload products by suppliers and load orders to deliver will speed up the process and in this manner increase delivery speed. Also a facility that is located near big traffic intersections will have an advantage in delivery speed because transportation will be able to move around quicker than if trucks need to drive through little back roads.

3.4 Analytical Hierarchy Process

Because a facility problem deals with multiple criteria and considers a small set of alternatives, the Analytical Hierarchy Process (AHP) is a suitable approach as explained in chapter 1. In order to find a suitable warehouse facility alternative the AHP will be used. This method allows decisions to be made based on both qualitative and quantitative criteria. This paragraph will describe the step in this process in more detail. The case example in chapter 4 will give a full example of the application of AHP.

Paragraph 3.3 discussed the elements to enable customer service that need to be considered for facility decisions according to theory and identified multiple criteria that need to be taken into account that derive from all three areas in business logistics. To further reach the research objective, these findings will be applied to a real-life setting via a case-study by using a framework provided by Thomas Saaty (1980). The use of the Analytic Hierarchy Process is suitable because this framework combines objective criteria with subjective elements that need to be considered because the every company has different opinions about the importance of the criteria. AHP makes it possible to combine these and results in an objective conclusion about selecting an alternative.

The framework for a warehouse location selection process contains four phases, namely; • Hierarchy building

• Priority establishment • Calculations of the ratings • Alternative comparison

33 Figure 6: Analytic Hierarchy Process phases (Saaty, 1980)

Step 1: Hierarchy building

To establish the hierarchy to be used in reaching a decision, first the main goal or objective will be established. For the first level of evaluation criteria elements of a strategic planning level will be indicated to outline the major factors that will be considered. After this, sub criteria that are linked to the elements of the strategic planning level will be identified on a tactical level and placed within the hierarchy. These criteria and sub criteria will be based on theoretical information gathered in the chapter theoretical foundations and information resulting from customer and supplier analyses. Step 2: Priority establishment

After all the criteria are indicated in the hierarchy, the subjective element of decision making needs to be incorporated into the equation and will be done using paired comparison. The criteria will be scored by the decision makers.

The decision maker will rank the identified criteria on a 1 to 5 scale, with 5 indicating high priority and 1 indicating low priority. This way the relative importance or preference for each criterion will become clear when the paired comparison approach is used.

The paired comparison approach will be calculated as follows: