How to justify a warehouse?

Warehousing is often regarded as a necessary evil that needs to be marginalized, if not eliminated. Although, we strongly disagree with this point of view in general, occasionally the value of warehousing might be redundant as demonstrated by the following case study.

 

Case Study: Office Supplies for Non-profit Organization

A non-profit organization held a central inventory of office supplies. A study revealed that it would be cheaper and quicker if the various branches ordered the office supplies directly from the wholesaler. Apparently, the distribution center only incurred costs and increased response times. The organization immediately decided to terminate the distribution center.

 

In most instances the distribution center does add value to the supply chain. Hence, it is important to understand the value of a distribution center. We distinguish four basic warehouse functions that add value:

  • Break-bulk
  • Storage
  • Consolidation
  • Customization.

 

Break-bulk

The break-bulk function allows for products to arrive in large quantities and then be shipped in small quantities. This enables economies of scale upstream in production, purchasing and inbound transportation. At the same time, it improves customer service since customers can order the specific quantity they want.

 

Storage

The storage of goods helps manage time delays between supply and demand. Having inventory serves various purposes:

  • Instant availability. The available inventory furnishes customer demand within short response times. Clearly, this improves customer service.
  • Lot sizes. Inventory due to large production runs or purchase quantities creates economies of scale in production, transportation and order processing.
  • Seasonal supply. Storage of fresh produce (e.g., apples and potatoes) smoothes the level of supply throughout the year. Without distribution centers the prices and supply of seasonal products would fluctuate wildly.
  • Demand anticipation. Storage allows availability of products during peak demand (e.g., toys in December). Without distribution centers an immense production capacity would be required.
  • Speculation. Inventory, often raw materials, held because it is expected that prices will rise.
  • Strategic products. Inventory of essential products with uncertain supply, e.g., rare metals.

 

Consolidation

The consolidation function implies that the distribution center holds products from various sources, so that customers can order a large product range from a single source. This improves customer service since the goods can be received in a single delivery. It also increases the efficiency of outbound transportation.

 

Customization

Customers may want products that are customized to their needs. Examples are customer or country specific labels, manuals or packaging. These, and other, value added services provide better service to customers. Furthermore, the postponement of customization services until the end of the supply chain reduces  upstream inventories.

 

We should emphasize that a distribution center not only adds value through physical activities. The distribution center may also gather and maintain related information and then inform supply chain partners as required. Hence, information provision is a prominent aspect of each of the four basic warehouse functions.

 

Notice that the distribution center in the previous case study did not support any of these four functions. Thus it only added costs, not value. The key message is this: it is essential to first justify whether a distribution center is needed. This may be done by evaluating the four basic warehouse functions. What would happen if we eliminated the distribution center? Would it negatively impact customer service? Would it increase the overall costs of the supply chain? In short, if a distribution center fails to support one or several of the warehouse functions, then one should consider the option of eliminating it.

 

It may also be that there is a subset of the goods flow for which the distribution center does not add value. The following case study gives an example of a distribution center with a break-bulk function for only 50 percent of its volume.

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