Many retail and ecommerce companies are feeling more pressure to reduce time in transit to the end customer, pushing the operations to provide options for supporting this. Being closer to the customer in general is a good thing, but for many companies, this can lead to disaster. Because of the complexity, it’s easy to under-estimate the order processing, WMS, and process changes required; recruiting and hiring costs; additional inventory investment and the financial implications.
It’s not uncommon for businesses to commit to multi-DC, only to have disastrous results which can cost the business significant cash and erode the customer base, or worse, put them out of business. Our objective isn’t to dissuade companies from going multi-DC, but to identify the risks, costs and where companies fail to properly plan and execute.
Factors Pushing Companies to Consider Multiple Distribution Centers
In our distribution center consulting, we have helped a significant number of companies be successful in implementing a multi-DC strategy. The reasons for why a company should consider this strategy must be sound and well planned. The following are the 3 most common factors we encounter for why people consider this supply chain strategy.
- Competitive pressure. A significant amount of pressure comes from Amazon, larger retailers and competitors that have significant distribution networks and are able to provide same day to two days from a shipping perspective. For companies selling common, open market goods, the consumer has options. Retailers that offer quick delivery with little to no freight costs will certainly have an advantage.
- Freight cost reduction. Small parcel freight, as well as LTL and FTL, have been escalating faster than in recent memory. Companies consider opening a second distribution center to reduce the freight costs, especially if free freight is offered from a marketing perspective. Inbound freight to multi-DCs must also be considered. However, more than one company has discovered the hard way that this strategy can have the opposite effect – more on this further below.
- Third Party Logistics (3PL) options. 3PL providers have been growing exponentially, with many opening somewhere between three to six facilities each year. This allows a 3PL to provide a significantly expanded multi-DC network to retailers and ecommerce companies. Internal pressure is put on the operations to leverage a 3PLs network or to expand internally managed DCs.
Why Companies Fail at Implementing Multi-DC Strategies
As warehouse consultants, we have the unique perspective of observing and assisting hundreds of businesses. Our goal is always to educate companies, helping to identify the risks, costs and how to mitigate those risks with proper planning. The following is not only how companies have failed, but a checklist that can be used to determine if you have properly planned to deal with various contingencies.
1. Thinking it Will Lower Freight Costs Without Doing an Analysis
Lowering freight costs is one of the predominant reasons why companies look to expand the distribution footprint, regardless of whether it is through 3PLs or internally managed facilities. The assumption is that being closer to the customer means reduced freight costs as you are not shipping across all zones.
Unfortunately, the reality for some business will be the opposite, and this is where supply chain professionals get into trouble without doing an analysis. The reason for this is somewhat straightforward.
Hypothetically, if you have a facility on the east coast, and opt to open a west coast facility in Salt Lake City or Reno, your goal is to reduce time in transit and the zones you are shipping to. From a carrier perspective, those shipments going from your east coast distribution center to the west coast are the most profitable shipments for the carriers. It gives them the opportunity to consolidate and be more efficient with the delivery side.
When you remove the most profitable freight, depending on package characteristics, etc., carriers will re-evaluate the freight contracts and pricing, and this can lead to the carriers increasing your freight costs. This can occur through raising your overall prices, affect the minimums, or even the accessorial line-item costs.
As part of any potential expansion of the distribution network, companies must first begin with a freight and transportation analysis. This analysis is critical to determining everything from where the optimal location from a distribution perspective is, to understanding the net impact on both inbound and outbound freight.
A proper analysis will also allow your company to understand how the inbound freight should be routed, as well as opportunities for potentially utilizing regional carriers (even for small parcel deliveries) for outbound shipments. This type of analysis can be easily performed, and there is no substitute or excuse for failing to properly analyze freight. This unfortunately tends to be something that is an afterthought or held until the very end, regardless, this will create overall problems in your planning process.
Things to consider:
- Have you performed an analysis with a high degree of accuracy and confidence to understand the true net impact on inbound and outbound freight?
- Have you considered utilizing a third party that has complex modeling capabilities, as well as the skillsets to compare your contractual rates to those of other carriers, to determine the best options and outcomes?
- Do you know if regional carriers are an option for your shipments?
2. Failure to Properly Plan Safety Stock and Order Processing
When companies first expand their distribution center network, many don’t properly plan the amount of safety stock needed to support the customer demand that each distribution center services. Your current inventory position in a single distribution center has a level of safety stock needed to support the demand. When implementing a second facility, that safety stock is no longer sufficient. You can’t simply take on a new west coast facility supporting 30% of the demand and allocate 30% of the planned or existing inventory.
The reason for this is that customer purchase patterns, the timing of inbound receipts and even activities like customer returns will impact the inventory needed in each facility. From our experience, it is not uncommon for companies to need an additional 15% to 20% more inventory on the low end to as much as 35% to 40% on the upper end for the second DC. This multiplication factor increases as third and subsequent DCs are added.
At the same time, there is a major risk in simply over buying inventory and creating further downstream problems that erode margin and consume more storage space than initial planned. More, on this below.
Things to consider:
- How disruptive is your current supply chain and the ability to bring in goods in a timely manner?
- Does your order processing system have the ability to operate in a multi-DC environment (e.g., customer order shipping by DC; will you split fulfill individual orders?
- How will you measure shipping costs per order versus shipping costs collected or built into the margin?
- Should you carry 100% of the product assortment or just a subset – such as replicating just the top 20% from a velocity perspective?
3. Failure to Properly Plan and Forecast Inventory
The inability to properly plan and forecast inventory is something that plagues many businesses. Adding additional distribution centers magnifies the problem and creates many operational issues that can be difficult to quickly overcome. Companies must have not only the right inventory planning and forecasting tools, but also the right individuals that can properly execute. Planning and forecasting are as much art as it is science, and just like hiring the right marketers – companies must find those inventory professionals that have the aptitude and experience for planning multi-DC inventory.
Some companies fall into the trap of promoting tenured employees simply due to the fact that they have been there and understand the business. This doesn’t necessarily mean they have the analytical skillsets to manage, plan and forecast inventory for potentially thousands of SKUs across DCs. In addition, having the right people in place without the right systems and tools can yield similarly disastrous results.
Another trap companies fall into is in leveraging 3PL networks and thinking that a 3PL’s tools will aid in your planning and forecasting – or that the 3PLs can do this planning for you. Don’t take this as being against the use of 3PLs, but more about being very wary of those 3PLs that suggest these capabilities. The reasons for this are straight forward. 3PLs do not understand your vendors, items, customers, or marketing strategies. Do you really want them making day-to-day purchases and financial commitments for your largest asset?
Things to consider:
- What will be your distribution strategy (e.g., ship directly to each DC; ship into one DC, breakdown and redistribute affecting minimum freight costs, inventory availability; will you redistribute inventory imbalances?)
- How accurate is your current inventory planning and forecasting? Considering fill rates and excess inventory.
- Do your purchasing/inventory departments have analytical skills and experience in planning inventory for multiple DCs?
- Are your systems sufficient to support planning inventory with your desired distribution network strategy?
4. Not Having a Cost-Effective Liquidation Strategy for Excessive Inventory and Obsolete SKUs
This happens to be one of the biggest challenges for most businesses, regardless of how many distribution centers. For retail and ecommerce businesses, it’s about planning and purchasing for the next season – and with product lead times growing longer, there is very little time from one set of decisions to the next.
From our experience, companies struggle to identify excess inventory positions in a timely manner. This creates significant congestion in distribution centers and erodes margin due to inventory carrying costs. If utilizing a 3PL, reduced turns not only becomes expensive (e.g., storage costs) but can also deter 3PLs from wanting to expand your business into other distribution centers.
Excess inventory isn’t the only problem, as you can have excess inventory from good performing SKUs, but companies tend to not move aggressively enough at eliminating obsolete SKUs. These SKUs and their respective inventory positions also create congestion in the warehouse and consume valuable space that could be better utilized by new products.
Things to consider:
- Do you have sufficient systems to identify excess inventory positions before they become problematic for the operations? Do your systems calculate “weeks of supply” based on item selling rates?
- Are you measuring margin erosion due to inventory carrying costs?
- Do you have a well-defined process for identifying and eliminating obsolete products from the warehouse?
- Does purchasing and inventory management have the discipline and track record for being aggressive in liquidating slow movers and overstocks?
5. Failure to Hire the Right Individuals
For those companies that open internally managed distribution centers, recruiting and hiring the right management team can be one of the biggest problems. This isn’t just about hiring the right distribution manager, its also about having the right supervisors and department leads to help train and reinforce Standard Operating Procedures (SOPs) and management expectations. If this management team isn’t working cohesively, you will struggle to meet your goals and objectives.
The challenges become more complex as you seek to recruit and hire for management of a remote warehouse. In these environments, it can be very difficult to extend your company’s culture and expectations to remote facilities that are hundreds to thousands of miles away. Traveling to a remote facility frequently has the potential to become cost and time prohibitive. It might be better to hire a more senior manager.
With the high cost associated with paying recruiters, and premiums to temporary staffing agencies, its not uncommon for companies to underbudget these costs because they don’t accurately estimate personnel turnover and attendant costs. With high rates of employee turnover and labor shortages, the training and HR costs increase dramatically. In addition, most companies tend to underbudget the time and travel costs for upper management to be onsite at the new facility to train and oversee the opening of each additional facility.
Bringing a new internally managed center on-line may take 12 months or longer from selecting the site and signing the lease agreement; and 24 months or longer for build to suit. During the start-up most centers take several months to get the new employees, leads and managers up to expected productivity levels. Using 3PLs may shave time off the startup time.
Things to consider:
- Have you budgeted appropriately for recruitment and agency fees for new hires?
- Have you factored in a realistic turnover rate, and subsequent HR, training, and agency fees?
- Have you budgeted for upper management’s time and travel to the new location to properly bring online the new facility?
- Can your company be successful with a remote location? Will distance be a problem in being able to extend your company’s culture and have them feel they are a part of your team and deliver high customer service?
- Do you have well developed SOPs that are adaptable to the new facility? Will your operating metrics and productivity reporting give you the visibility you need?
- Are you realistic in terms of how long it will take to plan, layout, implement material handling, WMS and processes as well as recruit and train the appropriate staff?
- Have you analyzed the cost of opening a subsequent facility, versus the cost of upgrading freight to those same customers?
- Is there opportunity to negotiate upgraded freight options with carriers to eliminate needing to expand your distribution network?
- If utilizing 3PLs for fulfillment, is their proposed rate less expensive than your own? If you were to migrate some portion of your volume to the 3PL, how will this affect your remaining carrier volumes from a pricing perspective?
When evaluating multi-DC networks, companies need to understand the costs, risks and operational changes required. Without proper planning of all these aspects, your multi-DC strategy will not be successful. Taking the time to analyze and properly budget is far less expensive than prematurely opening an additional distribution center. In the end, expanding the number of distribution sites is the right choice for a fair number of companies. However, this type of analysis and planning is the only way to be sure it’s right for your company.