Designing fee tables for retail delivery services by third-party logistics providers

Abstract

Manufacturers are increasingly relying on third-party logistics service providers to distribute their products to retail stores. Fee tables, specifying how much to pay for each delivery based on weight and distance, are commonly used as the basis for compensating distributors for their delivery services. This article proposes and solves an optimization model to help a large building products manufacturer design an appropriate fee table for payments to its distributors for delivering products from regional distribution centers to retail stores. Given the distance and the distribution of shipment weights to each store served by every distribution center, the model selects the weight and distance ranges of the fee table and sets the fees for each combination of ranges to minimize total distribution costs while satisfying fee structure requirements and ensuring adequate total compensation for each distributor. Since the problem is difficult to solve using commercial solvers, we develop a tailored approach to obtain near-optimal solutions quickly by adding valid inequalities to strengthen the model formulation and using an optimization-based procedure to generate a heuristic solution. When applied to actual data from the building products manufacturer, our Composite solution method, combining cutting planes and heuristic, was effective (yielding solutions that are within 1% of optimality) and generated substantial savings (of nearly 10%) over the current fee table.

Keywords:

• Third-party logistics
• fee tables
• optimization
• cutting planes

Additional information

Notes on contributors

Anantaram Balakrishnan

Anantaram Balakrishnan is a Professor in the Information, Risk, and Operations Management Department and holds the Jastrow Chair in Business at the McCombs School of Business, University of Texas at Austin. His primary research interests are in operations and supply chain management and optimization. His research, motivated by practical decision problems and often conducted collaboratively with companies, largely focuses on developing effective optimization models and tailored solution methods to address strategic, tactical, and operational planning problems in manufacturing, logistics, telecommunications, and supply chain management.

Harihara Prasad Natarajan

Harihara Prasad Natarajan is Associate Professor of Operations and Supply Chain Management at the University of Miami's School of Business Administration. His research develops optimization models, theory, and algorithms to solve practical decision problems. Motivated by collaborative projects with industry partners, his current research investigates insights and methods for managerial decision problems in the areas of procurement, inventory control, distribution, and revenue management.