A delicate balance: New ideas in distribution network design
Companies are rethinking the number and size of distribution locations, which requires careful consideration of cost and service factors.
The age of omni-channel retailing is forcing companies to take a fresh look at the way they store and distribute product. That includes changing the way they determine the number and size of distribution centers in their networks.
Traditional wisdom dictated a fairly simple approach. For the past 15 years, North American distributors have relied on networks consisting of a small number of large, centralized warehouses, with the focus on efficiency and economies of scale.
But rising fuel costs and the need to respond faster to consumer expectations have led companies to modify their distribution strategies. A warehouse located halfway across the country can’t cope with shrinking order turnaround times, or the need to fulfill orders through a combination of bricks-and-mortar stores and the Internet.
In North America, those time and cost pressures are causing many companies to expand the distribution networks many of them shrunk not so long ago. For some, though, that strategy may carry risk.
Traditional wisdom dictated a fairly simple approach. For the past 15 years, North American distributors have relied on networks consisting of a small number of large, centralized warehouses, with the focus on efficiency and economies of scale.
But rising fuel costs and the need to respond faster to consumer expectations have led companies to modify their distribution strategies. A warehouse located halfway across the country can’t cope with shrinking order turnaround times, or the need to fulfill orders through a combination of bricks-and-mortar stores and the Internet.
In North America, those time and cost pressures are causing many companies to expand the distribution networks many of them shrunk not so long ago. For some, though, that strategy may carry risk.
Complex cost and service trade-offs
In retail, the explosion of e-commerce sales is forcing companies to get closer to consumers, who are demanding delivery within two days or less. “There’s no doubt that we’re seeing continued pressure to reduce the time between placing an order and receiving it,” says Mary C. Holcomb, Associate Professor of Supply Chain Management at the University of Tennessee.
The obvious move would be to switch to a network model consisting of smaller, regional distribution points. And that’s precisely what many companies are doing.
The smaller sites serve a different purpose than the mega warehouses. Instead of storing and moving full cartons or pallets of product destined for retail stores, they’re designed to fulfill orders placed by online buyers. Workers pick individual items (often referred to in North American warehouses as “eaches”) and ship them as small parcels, rather than building more cost-effective truckloads of goods.
Then there’s Amazon.com, which breaks all the rules by building regional facilities that are every bit as large as the old centralized sites. As of October 2014, the e-tailing giant was reportedly operating 131 distribution centers of varying size and scope worldwide, totaling 88.3 million square feet. The company has plans for 19 additional sites in North America, and five in other parts of the world.
“Amazon is [supporting] the best of both models,” says Michael Watson, Adjunct Professor at Northwestern University. “Because they’re a top-tier retailer, they can get both economies of scale and be closer to customers.”
To counter the Amazon challenge, traditional retailers have to be more creative than ever. For a growing number of them, their stores—with their advantage of being located in population-dense areas—are doing double duty as retail sites and inventory locations for e-commerce orders. It’s becoming increasingly common to find shoppers alongside store employees who are picking orders directly from the shelves to fulfill online orders. Under such a model, the bricks-and-mortar location functions much like other warehouses in a network.
Every decision about centralization versus localization involves a complex trade-off between cost and service. “The question is, how can I do this in a way that I charge my customers as little as possible while incurring the lowest cost?” says Sunil Chopra, IBM Distinguished Professor of Operations Management at Northwestern University’s Kellogg School of Management. He says retailers must eventually cover the expense of maintaining multi-site distribution networks, which raises questions about their ability to continue to offer the free shipping that many online buyers have come to see as the norm.
In some cases, Chopra says, retailers are actually pulling product back from their stores into distribution centers that are dedicated to e-commerce orders. Consumer electronics is one area where this trend is evident, he says. Chains such as Best Buy are placing more emphasis on online fulfillment, in response to the twin threats of pure e-tailers and “big-box” merchandisers such as Wal-Mart and Costco.
The expansion of distribution points isn’t just a question of scattering the same amount of inventory among more locations. The total volume of product in the pipeline is greater, placing an additional burden on balance sheets, Chopra says. Whether that makes economic sense depends on the sales volume, value, velocity, and predictability of demand for a given item. If the numbers are high on all counts, then a retailer can justify positioning product closer to the consumer. After all, it’s saving a significant amount of money on fuel because of the shorter haul to the point of sale.
The obvious move would be to switch to a network model consisting of smaller, regional distribution points. And that’s precisely what many companies are doing.
The smaller sites serve a different purpose than the mega warehouses. Instead of storing and moving full cartons or pallets of product destined for retail stores, they’re designed to fulfill orders placed by online buyers. Workers pick individual items (often referred to in North American warehouses as “eaches”) and ship them as small parcels, rather than building more cost-effective truckloads of goods.
Then there’s Amazon.com, which breaks all the rules by building regional facilities that are every bit as large as the old centralized sites. As of October 2014, the e-tailing giant was reportedly operating 131 distribution centers of varying size and scope worldwide, totaling 88.3 million square feet. The company has plans for 19 additional sites in North America, and five in other parts of the world.
“Amazon is [supporting] the best of both models,” says Michael Watson, Adjunct Professor at Northwestern University. “Because they’re a top-tier retailer, they can get both economies of scale and be closer to customers.”
To counter the Amazon challenge, traditional retailers have to be more creative than ever. For a growing number of them, their stores—with their advantage of being located in population-dense areas—are doing double duty as retail sites and inventory locations for e-commerce orders. It’s becoming increasingly common to find shoppers alongside store employees who are picking orders directly from the shelves to fulfill online orders. Under such a model, the bricks-and-mortar location functions much like other warehouses in a network.
Every decision about centralization versus localization involves a complex trade-off between cost and service. “The question is, how can I do this in a way that I charge my customers as little as possible while incurring the lowest cost?” says Sunil Chopra, IBM Distinguished Professor of Operations Management at Northwestern University’s Kellogg School of Management. He says retailers must eventually cover the expense of maintaining multi-site distribution networks, which raises questions about their ability to continue to offer the free shipping that many online buyers have come to see as the norm.
In some cases, Chopra says, retailers are actually pulling product back from their stores into distribution centers that are dedicated to e-commerce orders. Consumer electronics is one area where this trend is evident, he says. Chains such as Best Buy are placing more emphasis on online fulfillment, in response to the twin threats of pure e-tailers and “big-box” merchandisers such as Wal-Mart and Costco.
The expansion of distribution points isn’t just a question of scattering the same amount of inventory among more locations. The total volume of product in the pipeline is greater, placing an additional burden on balance sheets, Chopra says. Whether that makes economic sense depends on the sales volume, value, velocity, and predictability of demand for a given item. If the numbers are high on all counts, then a retailer can justify positioning product closer to the consumer. After all, it’s saving a significant amount of money on fuel because of the shorter haul to the point of sale.
A different direction in Europe
The move to regionalized distribution in North America isn’t necessarily being duplicated elsewhere. Europe, for example, is seeing a continuation of the trend towards centralization, says Jeroen Martens, Director of Supply Chain Consulting and Network Design with DHL Supply Chain, Europe. Distributors have long taken advantage of the relatively short distances between Western European countries as well as the ease of crossing borders within the European Union.
Belgium and the Netherlands remain favored host countries for region-wide distribution, says Martens. At the same time, European supply networks are making changes in line with shifting consumer markets and higher operating costs. Western Germany offers lower labor rates while retaining the advantage of proximity to major ports. And the opening of new markets in Eastern Europe is being accompanied by new distribution facilities in countries such as Slovakia and Hungary, which can’t be efficiently served from warehouses in the West.
As in the U.S., European sellers are offering overnight delivery or even same-day service within certain urban centers. That strategy clearly calls for more distribution sites placed close to the customer. Martens says retailers are relying on local parcel-handling networks to cover the “last mile” of an order’s journey to the online purchaser. For the most part, however, the European network model remains highly dependent on the concept of centralization.
No single strategy fits the needs of every retailer or distributor, which must contend with ever-rising costs and service demands. New analytics tools “give you the power to do different trade-offs,” says Watson, “but in the end, someone has to make a tough decision. It’s a hard calculation.”
Belgium and the Netherlands remain favored host countries for region-wide distribution, says Martens. At the same time, European supply networks are making changes in line with shifting consumer markets and higher operating costs. Western Germany offers lower labor rates while retaining the advantage of proximity to major ports. And the opening of new markets in Eastern Europe is being accompanied by new distribution facilities in countries such as Slovakia and Hungary, which can’t be efficiently served from warehouses in the West.
As in the U.S., European sellers are offering overnight delivery or even same-day service within certain urban centers. That strategy clearly calls for more distribution sites placed close to the customer. Martens says retailers are relying on local parcel-handling networks to cover the “last mile” of an order’s journey to the online purchaser. For the most part, however, the European network model remains highly dependent on the concept of centralization.
No single strategy fits the needs of every retailer or distributor, which must contend with ever-rising costs and service demands. New analytics tools “give you the power to do different trade-offs,” says Watson, “but in the end, someone has to make a tough decision. It’s a hard calculation.”
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