Budgeting for Facility Upgrades

Sep 01, 2005 9:30 PM  By

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