Evaluating Inventory Costs For Multi-Distribution Center Processing

In operating multiple DCs, one of the major on-going costs is the additional inventory at the SKU level that will be required. Many times, companies are surprised at the magnitude of the inventory increases. Our experience is that a second DC adds 30% more overall inventory in a company, then just having a single DC. A third center may add 50% more overall inventory, then a single DC. Obviously, the increase doesn’t automatically correlate to the company being able to achieve 30% and 50% higher sales without some major marketing and promotional changes.

 Multi-DC operations are not just for the mega companies. We have had several clients with sales in the $20 million sales range open a second center and have an increase in sales. Additionally, 3PLs need to hit a high percent of the US population to remain competitive.

As part of planning a second facility, there are inventory systems requirements that will be necessary to manage multi-DC inventories, and fill customer orders. 

Here are some factors that create the inventory increases cited above:

• Merchandise by DC. As you’re thinking about inventory in multiple locations, what should be your strategy for stocking the DCs? In multiple DC projects we have worked on, the best selling products (maybe 20% of items with 70% to 89% total sales) are housed in all centers and slow sellers in one facility. This may reduce inventory costs but it tends to increase second carton shipping costs. Start by thinking strategically about how you would plan the assortment by DC.  

• SKU Planning. SKU forecasting is not an exact science in most businesses. The plans must be at a SKU and location level. It’s not just simply a percentage increase to a purchase order. How will shipments to multi-locations change minimums purchases from vendors and freight costs?

• Change in sales pattern. How will the addition of a DC change the sales pattern? Each location may sell differently. Let’s say your planned facility is to serve western states customers. Based on your two centers, what states and the respective populations will be served by each center?  

• SKU Depth. If the products are color/size, or dimensional products like apparel and shoes, often times they are not stocked in tremendous SKU depth. In the planning process how will this change the inventory levels? There is the risk of being overstocked on new products or fashion products which you do not have sales history for when you plan inventories.

• Will returns come back to the original shipping facility to be used to fill other customer orders? Or will they be processed in one facility? This affects the inventory levels especially where high return products are concerned.

• Liquidation and profit risks. If you end up buying substantially more inventory, is it the type of product that can be held for later promotions? Or is it seasonal or fashion which has a limited style life? What are your assumptions about planning liquidation costs, and are they higher than a single facility?

 These are a few of the reasons why inventory tends to be much higher to support a second, and subsequent DCs. There is also the human tendency to build in a “safety factor” to create the best coverage.

Systems Functionality

In order to support multi distribution center processing, your company will need to consider additional information systems technology.

• Order management and inventory allocation. The warehousing and order management systems logic must have business rules that allocate where the customer’s order will be filled. Are all SKUs in the same center closest to the customer? If not, what decisions do you want the system to make without manual intervention? Obviously, how well this logic works with the inventory availability by location will determine if you achieve the savings from freight or you add costs per order with second shipments from another center.
• SKU planning by DC. Does your company have formalized inventory planning systems that are multi-location? Many companies still use homegrown spreadsheets. New systems will need to have required history for customer shipments by DC and know how sales and inventory were originally planned to help support the new plan. Other features will assist in making the SKU unit plans and the dollar plans.

Multi-DC operations have many advantage, however, they clearly have increased new costs of which inventory is a major on-going expense. It’s important to keep in mind that 44% of the US population lives within 20 minutes of an Amazon facility. As Amazon grows stronger and is successful with its Prime Now and immediate shipment, more and more companies will assess how multi-DC operations build sales.