Budgeting for Facility Upgrades

Allocating sufficient resources to fund a distribution center move or expansion is a momentous undertaking that requires months of meticulous planning, research, and negotiation. The first part of this series, published in the September 2005 issue, focused on macro issues such as real estate costs, building size and shape, and site selection. This article deals with micro-level budgeting for facility equipment and business processes. n Once you have selected your site and decided on the type of commercial space you’re looking for, you’re ready to proceed to the next, and critical, stage — a detailed building evaluation. If you plan to lease a facility, always try to find more than one structure in any area. Minimum criteria for comparison include the following:

  • utility adequacy, especially sewer and fire-suppression water

  • expansion potential, perhaps for a call center

  • adequacy of dock space (one dock per 1,200 sq. ft. of staging area, or one dock per $10 million of annual sales) and “apron” space for an equal number of trailer parking spaces

  • adequacy of employee parking

  • condition of air-handling and refrigeration equipment

  • estimated operations expense (heat, light, taxes, common area maintenance [CAM] charges)

  • access to truck routes

  • proximity to major shippers

Assign one person in your organization to speak for the company when dealing with real estate brokers and landlords. If you wish not to tie up your staff with the details, you can select a “buyer’s broker” in exchange for a 6%-10% transaction fee, but most fulfillment companies prefer to manage the process inhouse.

Next, create a description of what you are looking for, contact the major developers/landlords in your area, build a spreadsheet, and rate the results as they come in. Take along your operations staff to visit the leading candidates. Call for final offers by a certain date. If you do not find your ideal building, the rental community is at least aware of what you are seeking and will contact you when and if it becomes available.

Allow four to six weeks for this stage. With the exception of the distraction and the staff time it will take to make a few visits and evaluate the results, costs should be negligible. Don’t panic, but don’t wait until you are confronted with a time crunch either.

Do we have the right equipment?

This is the most difficult question to answer with any specificity when addressing a wide audience. As one DC manager told me, “There is no such thing as ‘state of the art’ in operations.” Since every direct commerce business offers a unique combination of products to a specific market sector, there is no magic solution that works perfectly at some given moment in the growth of your operation. A frustrated operations executive once warned me, “Listening to you makes me want to cut off one of your arms! Then you will have to stop using your favorite expression, ‘on the other hand!’”

A good rule of thumb used to be that $10 per sq. ft. would equip your plain-vanilla DC. Well, ladies and gentlemen, once you reach 100,000 sq. ft., we’re starting to talk real money.

Lasting solutions can be expensive and fugitive. To provide an appropriate array of fulfillment equipment, engineers and suppliers must first learn all they can about your business. They usually charge you for the education. Then, with any luck, they can develop a relationship with you that will allow them to continue to adjust, enhance, and supplement the hardware and software to meet your ever-changing requirements.

This process requires a genuine sharing of information that many companies view as highly proprietary. Wal-Mart has been willing to take the risk, approaching its suppliers as if they were partners, not adversaries, and implementing a collaborative planning, forecasting, and replenishment (CPFR) program that has reduced inventory carrying costs for all parties involved. The result of squeezing excess inventory out of the supply chain is an estimated 5%-10% price advantage to Wal-Mart. That benefits the consumer, Wal-Mart, and the manufacturer, since the latter can now sell more of its product to a fewer number of buyers, with lower risk and less administration.

It is always interesting to grasp that you save on inventory holding costs by processing just the right amount of product. It is very hard to train buyers to think this way. Everybody gravitates to the comfort of a “cushion.” So there are no reliable estimates of just how much equipment to buy or how many systems to install, because so much depends on how much product you have on hand. But there is a way of approaching the equipment challenge that produces continuous improvement, increased productivity, and a well-funded retirement for anyone who uses it (not a bad offer, actually).

Conducting a business process review

The most successful approach to creating a good match between your operations needs and your facility’s equipment — and thereby arriving at a realistic cost estimate — is the competent conduct of a business process review (BPR). In the interest of clarity, I will oversimplify the procedure and reduce it to its simplest characteristics.

If we go backward through your operation, we start at the dock door and experience, in reverse order, the following predictable and usually discrete departments:

  1. manifesting
  2. packing
  3. picking
  4. reserve storage
  5. receiving (quality assurance)

If any one of these steps is faulty because of inconsistent methods or inaccurate prediction of demand, we also experience returns, whereupon products are reconditioned and reinjected into the system to await another chance at (yes, you guessed it) fulfillment.

If you “think like your merchandise,” you’ll see that there are a number of general conditions that all of us products would appreciate:

  • We would appreciate getting through your DC quickly.

  • We would like to be moved no more than five times (once for every department).

  • We would appreciate leaving your DC in the same or better condition than that in which we arrived.

  • We would like to be processed in a way that returns a good margin to you, our host, at an attractive price to our consumer. And as much as we love you, we would like to avoid coming back, because nobody likes a loser.

Like all compartmentalized processes in the material handling universe, risk and cost reside not in the operational departments themselves but in the journeys between departments. Certainly we need to be comfortable and protected when resting, but it is when we are in motion that the battle for margin and user satisfaction is won or lost.

Playing doctor

A well-performed business process review examines departmental efficiency and the flow of products and information among the departments. It concludes with a long-range, staged plan that will accompany you as you grow, and it makes specific recommendations to reduce waste and enhance productivity. Whew!

So how does an operations manager conduct a BPR, and what are its results (“deliverables”)? In the first part of this series, we discussed the idea of “listening for pain” the way a good doctor would. Here are some of the diagnostic tools available to the “DC doctor”:

  • data acquired from the patient file (DC performance data)

  • data acquired from well-considered questions (staff interviews)

  • examination (methodical observation, or “shadowing”)

From there it’s simply a matter of diagnosis and prescription — the BPR plan and recommendations.

Sounds quite simple, but as in medicine, it is very risky to diagnose yourself. In order to have a reliable result that will produce measurable improvement, it’s best to seek the advice of an independent outsider who has experience treating ailments like yours.

Practitioners include, in descending orders of expense:

  • Engineering consultant groups

  • Systems integrators (staffed by knowledgeable ex-vendors)

  • Small consultancies (like mine)

  • Equipment dealers (conveyor, rack, or forklift truck dealers)

  • Design/build contractors (Don’t laugh, these guys are getting good!)

According to Ian Hobkirk of Beacon Systems, a systems integrator located in Tewksbury, MA, a complete BPR should include an analysis of problem areas, in addition to a comprehensive diagram of existing operations, review of current procedures, proposal for a phased implementation of solutions, cost-justification of each improvement, and diagram of proposed operations. This document becomes an operations manual for your future DC.

Choosing a partner for the creation of a BPR is like choosing a heart surgeon. The last thing you should concern yourself with is the cost of the best advice you can get. Solicit proposals and interview their authors. Check references and choose carefully. Buying expertise on cost is like buying too-little real estate for a growing business — a false economy. Figure on spending, at the very least, eight to 12 weeks and $25,000 to $100,000, depending upon the experience and credibility of the practitioner and the complexity and size of your system.

When should I conduct a BPR?

If you manage a small DC, you should have a BPR in your head. If you manage a medium-sized DC, you should have a BPR in the works. If you manage a large DC, you should have a BPR on the office wall of each of your subordinate managers. You should be implementing the one you completed three years ago and reviewing the success or disappointments of each implemented phase. Finally, you should be planning to initiate the next one by speaking with your peers, visiting slightly larger facilities, and calculating whom to add to the planning group.

Louis Pasteur said, “Chance favors the prepared mind.” The prepared mind is characterized by a clear vision of where you are going next. Great hockey players skate to where the puck is going and prepare for it to arrive. Experience allows them to do this. When you hire consultants, it is their experience that you are renting.

A business process review is your road map through the next five years. It should be a living document, modified by experience and continual collaboration with the authors and the people running the systems. The BPR allows you to surround yourself and your subordinates with smart people determined to help you succeed.

Paying the price

As you prepare your business process review, ponder the second highest expense you control, labor. In a warehousing survey of 211 operations conducted by the Bala Cynwyd, PA-based consulting firm Spaide, Kuipers & Co., the respondents’ equipment costs went up as labor costs declined. There is an obvious conclusion to draw from this discovery: Reducing the costs of labor helps you pay for more equipment and systems. The table “Per-order labor costs” on page 57 shows that the higher the company’s sales, the lower the cost of direct labor per order. In this case, the direct labor cost of each order shrinks from $2.62 for companies with annual sales of less than $30 million to $1.33 for those with revenue of more than $100 million.

If you dwell on this correlation and do some simple math, you can see that the large DC has created a system that gives its operation a $6.37 million annual advantage over the smaller facility when having to fulfill its 4,941,000 orders. Schedule a quiet moment with your chief financial officer and make sure he understands this. It will make it much easier for you to justify the expense of a BPR and the implementation of the hardware and software that follows.

Remember, Wal-Mart has become what it is by cutting costs. This is not gloriously creative work, but if you are passionate and organized about it, it can make you rich.

Stephen Harris is a principal of Lincoln, VT-based Harris & Harris Consulting, specializing in distribution facility planning, design, and construction. Special thanks go to Ian Hobkirk, Ken Soper, and Ted Elkins at Beacon Systems in Tewksbury, MA.

PER-ORDER LABOR COSTS

Annual sales Less than $30 million $30 million-$100 million More than $100 million
Annual orders 138,000 403,000 4,941,000
Direct labor cost $2.62 $2.04 $1.33
Indirect labor cost $1.49 $1.23 $1.02
Total dist. cost $4.02 $3.87 $2.48
Cost/consumer order $4.02 $2.17 $1.80
Cost/b-to-b order $4.07 $6.98 $4.65
Source: Warehousing Survey, Spaide, Kuipers & Co., 2004; number of respondents = 211

When to relocate your DC

The need to relocate one’s warehouse or fulfillment center is frequently occasioned by storage or logistical logjams. Five fairly obvious symptoms of clutter:

  1. having less than 20% of pallet locations empty at any given time
  2. storing product in staging areas and aisles
  3. frequently needing to move one thing to get at another (excessive “touching”)
  4. constant replenishment of pick locations
  5. increasing employee injury rates

If your operation is experiencing any of the above maladies, take the time to chart a detailed map of your distribution center and its space utilization. Compare your diagram with the standards shown in “DC space allocation” at right. This is the one area where the numbers don’t change much as companies grow in sales.

Get your operations employees to think about variations and justify any wild discrepancies. (Usually there are good reasons for deviations from the norm.) Create a diagram of your ideal facility, and use this document as the basis of the request for proposal that you send to the site developers/landlords. If you choose to hire a facilitator to conduct this exercise, anticipate a time frame of eight weeks and $10,000 in fees.
SH

DC SPACE ALLOCATION

Annual sales Less than $30 million $30 million-$100 million More than $100 million
Total sq. ft. 27,000 118,000 481,000
Receiving 10% 11% 7%
Reserve 26% 36% 38%
Picking 45% 37% 37%
Packing 9% 8% 8%
Shipping 5% 5% 7%
Returns 4% 4% 5%
Source: Warehousing Survey, Spaide, Kuipers & Co., 2004; number of respondents = 211
Note: Numbers may not equal 100% due to rounding.

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Budgeting for Facility Upgrades

If you are serious about managing facility costs, you will have to grasp what Wal-Mart has accomplished, and how. An early adopter of every improvement available, Wal-Mart boasts its own fleet of trailer trucks, running full wherever they go (no dead heads); RFID license plates on every inbound pallet; forklift operators listening to selection instructions on headphones (in English or Spanish, male or female voice, gently informing them if they are behind schedule); real-time inventory control that goes directly from the point of sale straight to the manufacturer; and hurricane merchandising strategies that put beer and Pop-Tarts on the shelves of stores in storm-threatened areas as the weather moves in.

So what does all this mean to you? How can you answer the deceptively simple question “What can we do to upgrade our distribution center to be competitive while keeping an eye on costs?” And how do you even know if your costs are fat, skinny, or normal?

Luckily, most of us are not competing head-to-head with Wal-Mart. But we are competing in a landscape crowded with catalogs, Websites, and specialty stores. So we need to examine the performance of our industry, how our efforts compare with those of our peers, and what we must do to improve our standards. In this case, let’s focus on how — and whether — a new facility can improve operational efficiency, and what to consider when weighing a facility move.

The yardstick

As a consultant, I discover most problem areas by “listening for pain.” The time-honored discovery tools of any doctor include conducting an examination, analyzing data, and interviewing the patient. Paying especially close attention to the responses separates good medicine from malpractice. It is no different for operations consultants, except that in our case the patients are the practitioners, who include employees throughout the facility, from the president’s office to the loading dock.

Human nature always steers the conversation to the dysfunctional. Key phrases that will clue you in to areas that need attention include “too much overtime,” “continual stock-outs,” “not enough room,” “can’t meet our targets,” and “can’t find the time to get organized.” If you understand your own operations well enough to be familiar with the statistics, you probably already know where your most costly problems reside. But bear with me while we quickly review some of the basics. In this first section of our budgeting lesson, we will examine potential concerns at the macro level.

Do we have the right zip code?

Every business has a unique blend of products and a changing cadre of customers, but in general, the largest single cost you will deal with is shipping (see “Operating costs,” right).

It is the simple logistical reality of central location that has wedded FedEx to Memphis, TN, and made the Home of the Blues the hub of the overnight business. Memphis was originally chosen because of its favorable weather (it is the northern-most airport rarely closed by snow) and its geographical convenience to the West Coast and the East Coast.

Your house list may not extend to both coasts, but a quick review of your shipping patterns will give you a good idea of a lowest-cost point of origin for your shipments. Most companies do not situate their first distribution centers using this criterion, but satellite DCs are frequently located within two-day ground service for customers otherwise expensive to serve.

Let’s assume that you’ve decided to upgrade your facility by expanding it. Issues to consider when developing expansion strategies include

  • availability (and productivity) of the local labor force
  • communications infrastructure
  • political, regulatory, and tax incentives (key indicators of predictability)
  • cost of real estate (raw and improved)

Where goes the neighborhood?

To do a thorough job of analyzing your DC location, start a dialogue with your shipping companies, including the U.S. Postal Service. Once you have identified the appropriate zip code(s), begin conversations with third-party fulfillment services in those areas, development authorities, and businesses and consultants that can provide detailed demographic information. There are no secrets left; you’ll find a good stock of “spade ready” commercial real estate and existing buildings ready for lease.

Once you have identified a few prospects, arrange to visit them. Even if you don’t act immediately, the data you collect will allow you to spearhead long-term planning and end fruitless speculation about moving. I have seen motivated decision makers come to informed conclusions within six weeks after spending no more than $15,000 in consulting fees and travel expenses and investing no more than 25% of their time in the project.

Do we have the right address?

As we drop a little closer to the ground, let’s review some of the rules and guidelines for evaluating your building. You should start with an evaluation of your site:

  • Parking spaces should amount to 1.5 times the number of your peak work force, especially if your distribution facility is off the beaten path of bus routes. This apparent excess is necessary to allow for overlapping shift changes. If your facility includes a contact center, the number of parking spaces can get to be quite large. Employee convenience becomes important when you are competing for labor with your neighbors.

  • Acreage is in short supply — they are not making it any more! To obtain enough real estate to double your current operation, make sure that your site is nine times the size of your building’s footprint. (Trust me on this one. Nine is a magic number that has been proven to work time and again.) So, if you have a two-acre roof (roughly 90,000 sq. ft.), you should be on a piece of real estate nine times that size, or 18 acres. This will accommodate parking, access, building expansion, and typical industrial zoning restrictions and set-back requirements adequate to double in size.

Remember that the wonder of compound growth means that a business with sales growing at 10% in a year will double its orders in 7.5 years. At a 15% growth rate, that same business will double in five years! This is a rule of thumb especially important to remember when searching for real estate on which to build. Nationwide, spade-ready commercial real estate is available in a range of prices, from $25,000 to $50,000 an acre, so don’t skimp on land if you have a successful business. It will not take long for the false economy to catch up with you.

Sizes and shapes

Building size depends on product storage requirements (perishable or hard, size, weight, and velocity), customer profile (consumer or business), and seasonal variations. A handy average, however, comes from a warehousing survey conducted in 2004 by the Bala Cynwyd, PA-based consulting firm Spaide, Kuipers & Co. The survey of 211 operations came up with average sales/square foot dollar values for three company sizes based on annual sales: less than $30 million, $551/sq. ft.; $30 million-$100 million, $797/sq. ft.; and more than $100 million, $930/sq. ft. Simply pick the annual sales category that applies to your business, and divide your sales by its corresponding sales/square foot dollar value. For example, if your operation has annual sales of $90 million, divide that number by 797. You should have a building of around 113,000 sq. ft.

Too broad a generalization for your taste? Then use the common zoning regulation of one warehouse employee per 1,000 sq. ft., multiply by your peak employment and see what you get. (This number will be skewed if you have a contact center in your DC.) These two estimates should provide you with a range of sizes within which you should reasonably expect to find yourself.

  • Building shape is also important. Remember that in geometry, a square is the most efficient shape for enclosing area (square footage) with surface (building envelope), other than the circle. Circles are too expensive to build and impossible to expand, so you don’t see many DCs built in the round. But you can start with a square and expand on two sides, and end up with a square again. This has a direct bearing upon potential building sites. Many awkward, expensive buildings have been built on “bargain” real estate. Remember that good real estate usually costs less than $1 per square foot, while construction costs start at 50 times that amount.

  • Height is another discussion point worth a line or two here. As companies grow in size, they usually migrate to taller and taller buildings to take advantage of more efficient cube utilization in their reserve storage areas. In the Spaide, Kuipers & Co. survey, the square footage per pallet dropped from 26 to 20 to 9 as company size became larger. Start-ups are not usually aware of the disadvantages of low clearance, but experienced operations managers recognize the efficiencies of 30-ft. to 40-ft. clearance, and the numbers prove it.

Do not underestimate the challenge of selecting your optimal site in your target area. Once you create a clear mission statement — which must include an ultimate “build-out” estimate of size and a reliable employee count — you should anticipate a time investment of six weeks and an expenditure of $10,000 for the services of a trusted broker, a construction professional, and a logistics expert. Once in a great while, you can find all three skills in one person, but most often you will deal with three separate people. You will then need to have the opinions of all three expressed comparatively on no less than five alternatives. Due diligence takes time.

Note: The second part of this article, dealing with micro-level budgeting, will be published in our November issue.


Stephen Harris is principal of Harris & Harris Consulting, based in Lincoln, VT. He specializes in the planning, design, and construction of distribution facilities.

OPERATING COSTS

Annual sales Less than $30 million $30 million-$100 million More than $100 million
Cost as percentage of sales
Labor 6.6% 2.5% 1.9%
Overhead 3.5 1.3 0.7
Facilities 2.5 2.3 1.4
Supplies 1.1 0.6 1.4
Equipment 1.1 0.2 2.0
Data processing 1.0 0.4 0.5
Transportation 7.6 5.0 5.0
Communications 0.5 0.2 1.0
Shrinkage 0.4 0.8 0.0
Misc. 1.7 0.5 1.0
Source: Warehousing Survey, Spaide, Kuipers & Co., 2004; number of respondents = 211

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