The role of hubs and economies of scale in network expansion

Abstract

Freight distribution often operates on the basis of consolidation, which is achieved through the use of hub facilities that allow for economies of scale. Freight networks need to be expanded to meet future demand, to cater for new markets, and to accommodate trends in global supply chains, for which strategic decisions need to be made. These decisions mainly entail the number and location of new hubs to be established. As network expansions require significant capital, striking a balance between the benefits afforded by the new hubs and the expansion costs is crucial. This paper investigates a hub network expansion problem where the configuration of the resulting network is determined by the trade-off between the fixed costs of locating new hubs and new links, as well as routing costs of shipping commodities, and the cost reductions achieved through economies of scale, without imposing a predetermined network structure. This paper also describes a mixed integer programming formulation of the problem and a Benders decomposition algorithm that uses several enhancement techniques to efficiently solve the model to optimality. The application of the algorithm on a real-life case study arising in the expansion of the Indonesian freight transport network yields several managerial insights. In particular, expanding the network with additional hubs and links can yield substantial cost savings, averaging at 47.6%, although at the expense of an increase in the length of the commodity paths. Failing to operate the network at the selected level of economies of scale can result in an increase in the routing costs by up to 58.8%. Expanding the network with no additional hubs leads to a rise in total costs of up to 20.9%. Finally, lower economies of scale leads to an increase in the length of commodity paths, with the routing cost being identified as the most sensitive parameter.