Reprinted from INBOUND LOGISTICS, July, 2004
How Big Is Big Enough?
Establishing a network of centrally located mega DCs has its advantages—proximity to the customer, lower inventory, less building overhead, and cost savings driven by economies of scale. But setting up a Big Box warehouse network can also bring big challenges. Here's some advice on siting and sizing your distribution center network.
A number of major drivers figure into determining a company's distribution center network strategy. These factors start with inbound finished goods or materials—he source of your DC inventory, according to Michael Jones, partner, strategic logistics services, St. Onge Co., York, Pa.
"If the company is a manufacturer," Jones says, "the source of inbound goods would be its own plants; for retailers or distributors the source would be suppliers. Retailers usually have a lot of different suppliers in many locations, so inbound generally is not a big factor in choosing between a mega-or regional DC network.
For a manufacturer, however, inbound may be a factor," he says. "Pepsi or Coke, for example, have regional manufacturing plants producing the full line of product. Their product is mostly water so it's too expensive to ship it all over the country. That means they may have hundreds of manufacturing/bottling facilities, product is made regionally, and there's not a lot of reason to bring it together in one place, then re-distribute it."
A significant change in sourcing strategy—inbound freight—can cause an organization to rethink its DC network size and sites.
"If you're a large manufacturer that used to make product in Ohio, your DC network will be configured around a Midwest center," Jones says. "If you outsource production to Asia, suddenly your DC in Ohio doesn't look so good. Your inbound freights is coming in through the Port of Long Beach, and you have to truck or rail it 2,000 miles across the Unites States just to get to your DC. It makes much more sense to reconfigure your DC network in proximity to your ports to entry."
Next issue—the cost of the facility. "This is where you get into larger decision drivers," Jones notes. "Inventory is a big consideration. Companies with a lot of different SKUs, or high-value SKUs, or both, may want to go with a mega-DC network.
"A great example is spare parts in the electronics industry," he says. "A company may have 40,000 to 50,000 different items with a fair amount of value. If it operates six or seven regional facilities, carrying that inventory gets expensive." Security also becomes more complex and costly.
The more facilities a company operates, the more difficult it is to maintain consistent service levels, fill rates, and best practices across the network.
"Companies that have one location are more likely to have everything in stock," notes Mark Schroeder, senior vice president of operations with third-party logistics service provider DSC Logistics, Des Plaines, Ill. "If they spread inventory out, they could be out of stock at one or more locations. The more items a company has, and the higher the dollar inventory, the stronger the case for a consolidated DC network."
Companies are all over the board when it comes to how effective they are at managing multiple-site inventories. "Some organizations are atrocious at getting the right inventory in the right location," Schroeder says. "They view this simply as a cost of doing business. Others are pretty good at it. They closely track stock transfers and try to minimize them."
Another factor favoring centrally located mega-DCs is economies of scale—on labor, construction, and other such costs.
"Companies operating distribution centers up to 800,000 or one million square feet can take advantage of economies of scale all the way from job creation and government incentives to construction costs," explains David Moses, executive vice president, Clayco Construction Company, St. Louis.
"From a construction standpoint, there are significant economies of scale from building a large, million-square-foot facility as opposed to four 250,000-square-foot facilities," Moses says. "The construction savings inherent in a large DC may be enough to justify a more automated facility."
"Generally," says Jones, "when it comes to labor and real estate costs, individual hourly wage rates or square-foot costs aren't primary drives. You could pay $8 an hours vs. $12, or $4 per square foot vs. $6. But what really matters for these two components is the number of facilities.
Consider a company with high labor content," Jones says. "By centralizing, the company needs just one warehouse manager instead of seven, 10 supervisors instead of 28, and so on. The company also may be able to deploy automation, such as sortation or pick-to-light materials handling systems. Maybe the company can't afford to do that for seven centers, but if it can consolidate, it may have sufficient volume to justify the investment."
The same rule applies to IT infrastructure costs."By centralizing, a company might get greater consistency as far as system enhancement and improvements go. And, in general, best practices are easier to implement at one or two sites vs. seven, eight, or more," Schroeder says.
The next element to consider is outbound transportation. "Outbound freight is a reason to consider a regional DC approach," Jones notes. "Generally the more facilities a company has, the less it will spend on outbound freight," he says."This is particularly true for a single manufacturing location that ships a lot of small LTL orders. The company can ship truckload to a regional DC, then use that facility as a break bulk for local delivery.
For example, consider a company manufacturing a Pennsylvania that wants to distribute product to California," Jones says. "It's very expensive to ship 5,000-pound shipments to California. But the company can ship 40,000 pounds to a regional center, then break it down for local distribution. This cuts down on transportation costs significantly."
Of course, common sense stipulates that any location under consideration must offer sufficient infrastructure to support it. "This means primarily trucking service and labor availability," says Jones. "If a company needs 300 people for a DC, it could locate in an Iowa cornfield where land is cheap. But if the company can't get enough truck service, or find more than 50 people within a 100-mile radius to work there, that's not a viable choice." Companies don't operate based solely on pure costs. Customer service figures heavily in the decision mix.
"Many companies opt for smaller regional facilities for service reasons," Jones says. "A company that needs next-day or two-day service to its customers has to have a regional presence. It can't deliver that level of service from a single central facility."
DO MEGA DCs MAKE SENSE
"Order cycle and lead times are not as customer friendly with a mega-center strategy," notes Schroeder. "Goods have to travel greater distances and naturally take longer to get to their destination. "Food is definitely better served with a regional DC network," he says. "At the other extreme is the furniture industry, where lead times are eight to 10 weeks. Then it makes sense to serve customers from a single location. Electronics fall somewhere in the middle, with DC locations probably depending on ports of entry. The industry sector drives network configuration."
"A manufacturer," Schroeder adds, "can't take advantage of postponement strategies with a central DC model—for example, customizing product closer to the end customer. In an industry sector such as food, where there are a lot of regional display requirements, this can be a disadvantage. It makes more sense to postpone those activities until you are closer to the end customer market."
There are exceptions, of course. Take service parts. "A lot of companies use a single facility to serve the whole country," Jones says. "They may have a next-day service requirements, but they typically ship small parcels and are not so worried about paying more for premium service. If someone has a $2 million piece of equipment that's down, they don't care if they pay $5 to ship a single part. That's chump change when compared to the cost of either having the equipment out of service or maintaining millions of dollars of inventory at regional facilities."
Finally, companies must consider risk exposure in setting up their DC network. "Sometimes," Jones says, "companies have two or three facilities because they don't want too many eggs in one basket. If they have one DC and it burns down, they're out of business. There are cases where the risk is even too great with two facilities. One may handle 80 percent of the company's order fill volume. So there is still a big risk if that facility goes down."
In certain cases, companies decide to take the risk of doing business out of a single huge DC. "For companies with a single manufacturing location, whose customers order in truckload quantities and are not sensitive to outbound delivery times, a central facility works," Jones explains. "Take a paper mill, for example. A mill is very expensive to build. Customers tend to buy paper products—towels, toilet paper—in truckload quantities with high replenishment frequency. The paper company's risk of having a single DC is negated because it deals in fast-turning items that can be produced quickly.
At the same time, bulky paper products are low in value but very freight-cost intensive," he adds. "It's too expensive to ship product all around the country simply to put it into a DC then pull and ship it again."
DCs don't have to be all mega or all regional facilities. Companies may adopt a hybrid network solution. For example, a business could run finished goods through three DCs, but consolidate spare parts activities out of one of those three. That one DC would be a hybrid—two warehouses in one.
Companies can make any number of mistakes when siting and sizing distribution facilities. Three in particular cause the most problems:
1. Companies don't apply enough analytical horsepower to the matter. "They make a decision based on gut feel or broad assumptions.
Invariably they overlook or underestimate something," says Jones.
2. Companies optimize for one variable only—such as outbound freight rates or manufacturing costs. "That's why a specialized modeling tool is needed," Jones advises. "The math to consider all the variables simultaneously gets very complicated."
Recognizing this need, real estate services firm Trammell Crow Company, Atlanta, has allied with Chainalytics LLC to offer computerized network modeling analysis in addition to real estate services. "Bringing scientific decision-making technology into the process takes the emotional element out of the network design," says Tony Kepano, principal with Trammell Crow. "The software model is agnostic."
3. Companies analyze in too much detail and become paralyzed by data overload. "I've seen companies stuck on whether they will pay $1.20 or $1.30 per mile for outbound freight on a single lane," Jones says.
BUILDING A NETWORK
The starting point in network decision-making is understanding your transportation and distribution system requirements, then figuring out the ideal location and designing a building that maximizes flows and efficiencies.
"Once you wrap your arms around these issues," says Moses, "you can dictate the real estate and construction piece. For example, you need 800,00 square feet with 38 feet clear height, 85 dock doors, and so much space for parking. You work your way down the chain of variables to understand how you can build the most cost-efficient, effective facility network possible."
Designing and implementing a successful DC network strategy is a team exercise. These decisions affect every area of a company. "For that reason," says Schroeder, "DSC Logistics likes to make sure that within the client's organization we don't just deal with the logistics executive to analyze a distribution center network or locate a new facility. We have to interface with sales, manufacturing, and customer service functions. We can't dictate what's important to the client, but we will be real pains in the neck asking lots of questions and extracting what's truly important to them."
"You need a strong project manager to hold this effort together," advises Jones. "The project manager has to be able to coordinate a lot of people representing many different functional areas in the organization. And be sure to get senior management investment in the project early on.
"A company's DC network strategy depends on its key objectives for serving customers and managing the balance sheet. "A centralized DC network brings costs savings—lower inventory, less building overhead, less labor duplicity," says Kepano. "But it also moves you farther away from customers, so service might be affected. The trick is finding the right tradeoff between customer service and cost savings."
© Copyright July 2004. Inbound Logistics. All rights reserved.
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