As leading supply companies have begun to realise, an essential need is arising to look at distribution networks in a new way. Static plans with a five-year horizon will no longer ensure supply chain optimality, and once distribution network misalignment starts to creep in, so will inflation of network costs
Unfortunately, there is no silver bullet to stop distribution network misalignment. The only solutions are to review and optimise network design more frequently, and to apply your company’s smartest minds to predicting how retail markets might develop in the years to come.
If you’re in any doubt about the importance of frequent checks for distribution network misalignment, the consequences—seven of which I’ve dubbed “costequences” and outlined in this blog post—might just encourage a realignment of your thinking on the matter.
7 Expensive Blights of Misaligned Distribution Networks
1. Inventory Carrying Costs
Distribution network misalignment will almost certainly inflate your inventory carrying costs.
Why? Because when your distribution network is not balanced for efficient supply, you will inevitably try to cover variance and inefficiencies by carrying higher levels of buffer stock. Indeed, this safety inventory will be a necessity, if you are to reduce risk of service failures arising from:
- Excessive supply or service lead times
- Product loss/damage
- Picking or delivery errors
So you will carry more inventory than would be necessary in an optimised distribution network. In order to carry this inventory, you will be incurring some or all of the following expenses:
- Opportunity costs: the loss of return that might be achieved if the money spent on inventory was invested in another way
- The cost of finance to purchase or produce the inventory
- Tax and insurance costs
- Cost of labour involved in inventory handling
- Warehouse overhead
- MHE operating expenses
- Inventory damage, shrinkage, and/or obsolescence costs
These costs are likely to increase as time goes on and are rarely limited to a single warehouse facility. It’s probable that safety stock levels will increase across your network like a rising tide. Furthermore, companies carrying excess inventory commonly find that service levels continue to decline, despite high levels of safety or buffer stock existing within their distribution networks.
That’s exactly why you should review the alignment of your network periodically, and certainly consider distribution network misalignment as a possible root cause if your inventory costs show signs of increasing for no obvious reason.
2. Facility Costs
A fundamental reason for high inventory costs in misaligned networks is because storage facilities are no longer optimal in terms of number, capacity, or location. A thorough analysis of your distribution network might show that:
- You have more warehouses than are required to service your market
- You have too few warehouses to serve your market cost-effectively
- One or more of your storage facilities is located in the wrong place
- One or more of your warehouses has too much or too little capacity
If you have more warehouses than you need, you almost certainly have too much inventory.
If you have too few warehouses, you probably have to carry buffer stock. Inappropriate storage capacities can also lead to excess inventory situations and hence, over-investment in inventory.
However, if you have too many storage facilities, warehouses located in the wrong places, or just too much storage capacity, your company will also incur facility costs which are essentially unnecessary.
Analysis of your distribution network might show for example, that one or more of your warehouses is no longer necessary to sustain network performance. If closed, the facility costs would be saved and money made from the sale of the site. If the facility is leased, closure would save leasing costs, along with all the other expenses associated with running it.
While a warehouse closure might mean you must find some storage capacity elsewhere in your network, you could consider renting storage space only for peak periods, or investigate the possibility of reducing costs through outsourcing to a third party warehouse and logistics provider.
3. Labour Costs
Too much inventory, too many storage facilities, over-capacity, or poorly located warehouses can all lead to inflated labour costs. In fact, even misplaced or unnecessary flow-through/cross-dock facilities generate the need for labour which, in an optimised distribution network, might not be required.
Employing more people than strictly necessary, while perhaps benevolent, is not conducive to profitability, or to supporting growth and new jobs for which there is actually a need, and which are therefore ultimately more secure.
For every full-time employee hired by your company, your bottom line is impacted by:
- Salary payments
- Overtime payments
- Fringe benefits expenses
- Paid sick leave and other paid time-off
- Costs of covering absent staff
The excessive cost of labour might not apply only to warehouses. If your company utilises in-house transportation resources, you might be spending more than you need to in this area too, especially if you have more storage facilities than are warranted by customer distribution/location and service requirements.
Even if you have the optimum number of warehouse locations, and they are located in the best possible way to maintain distribution network effectiveness, capacity constraints within individual distribution nodes can still give rise to excessive labour costs.
If capacity proves to be an ongoing or even intermittent issue within your network, it might be worth considering whether older facilities should be closed, and replaced by more modern, modular warehouse designs which can quickly be flexed to cope with future demand peaks or troughs and manned by a flexible or outsourced workforce.
4. Transport Costs
I’ve already touched on how in-house transport costs can be impacted by distribution network misalignment. Whether your company’s transport needs are met by internal or external resources though, a network which is not optimised can easily result in excessive transport expenditure.
Excess inventory leads to excess transportation. The more warehouses you have, the more transport you use. A shortage of facilities will also lead to a greater need for transportation, as will warehouses located inappropriately to serve your market.
However, distribution network misalignment can generate excessive transport costs in other ways too, even if your distribution centres and warehouses are located perfectly. An optimal distribution network requires optimal transportation, both for warehouse replenishment and for delivering your products to customers.
Last-mile transportation in particular will do your budget no favours at all if not optimised, given that it typically comprises as much as 28% of total supply chain transport cost.
Questions to consider with regard to transport optimisation might include:
- Are you using the most efficient mode of transportation, or combination of modes?
- Are you using trucks of the right type, size and capacity for road transportation?
- Are you using the carriers that can serve your network in the most cost-efficient way?
- Should you be in-sourcing or outsourcing some or all of your transportation?
- Is your vehicle fleet over or under-utilised?
- Are your line-haul and/or route trade transport networks optimised daily to minimise distance, time, and fuel use?
All of the above considerations are vital for developing a logistics network that’s optimised for the market dynamics of your business.
Transportation infrastructures and facilities change over time, so what might have been working well a few years ago may be less than optimal today. The only way to find out is to stop and ask these questions every so often. The answers might reveal valuable opportunities to realign the transport element of your distribution network.
5. MHE and Other Equipment Costs
Excesses in inventory, inventory locations, labour, and transportation can all increase the number of equipment assets on your company’s books. Mechanical handling equipment in particular, is expensive to acquire and depreciates over time.
Moreover, asset utilisation only adds value when supporting an optimal process for matching demand and supply within your network.
Of course the worst-case scenario exists when you have too many inventory points in your network, since each location will need to be equipped with apparatus for receiving goods, putting them away, picking, and loading them.
Other symptoms of distribution network misalignment can also increase equipment costs. If supply lead times are too long or too variable for example, you might need extra equipment to handle peaks in inbound supply—equipment which then sits idle during slower periods. Optimal network design requires equipment, as well as storage space and transport resources, to be present in exactly the right quantities and utilised in the most productive manner.
In a network which is misaligned, assets can easily be over-stretched in some areas and woefully under-utilised in others.
Remember too, that equipment, fuel, spare parts, and other associated materials all count as inventory in your network, which ties up working capital and competes for valuable warehouse floor space. Then there is the other equipment that’s needed to manage and handle your direct goods inventory, such as racking, pallets, and packaging materials.
By now you should be starting to get a true picture of just how much money can be wasted by a misaligned distribution network. You should be noticing in particular, the interrelations between cost elements and how each can contribute negatively to others. However, it doesn’t stop here. There are two more distribution network cost elements which will almost always become “costequences” of distribution network misalignment.
6. System Costs
The cost of your company’s supply chain business information systems is connected most directly to the number of facilities in your network. Like all the other cost elements explored so far in this post, the more facilities you have, the higher your system costs will be.
That’s all well and good if your distribution network is aligned and optimised to deliver your supply chain strategy, but if not, your IT budget will be needlessly strained. Think about all the processes that can potentially require licences, software, hardware and maintenance/administrative resources in each of your DCs and warehouses. These might include:
- Warehouse management systems
- An ERP solution
- Inventory management applications
- Productivity software suites (MS Office or similar)
- Analytic software
- Desktop computers, laptops, mobile and handheld terminals and scanners
- Wired and/or wireless networks
- Server hardware
- Other assorted software and hardware
Even if you don’t have more inventory points than you really need, systems costs—along with all the others mentioned so far—will be more than they need to be if your distribution network is out of alignment.
The more inventory you carry, the more people you need to manage it, which means you need more software licenses for them to work with. If you make use of bar-coding, you need more scanners, some of which may be handheld and some mounted on fork lift trucks.
Of course there has to be a threshold, and a little inventory overage might not generate the need to increase these resources. Over time though, as your network becomes less well-balanced and more inventory creeps in, so does the risk of increased IT expenditure … which makes IT worthy of mention as a “costequence” of distribution network misalignment.
7. The Cost of Loss
Okay, so I’m guilty of leaving the worst till last, and of introducing a cost that you won’t find in most literature relating to distribution network optimisation—the cost of loss.
What do I mean by the cost of loss?
It’s like this; distribution network misalignment is a trigger for losses on many fronts.
What do you lose when your network is no longer, or never has been optimised? Here are a few possibilities:
- You can lose flexibility and adaptability in your supply chain
- You can lose the ability to ensure inventory is available when and where your customers want it
- You can lose service quality
- You can lose market penetration
- You can lose the conditions that support business growth
And if the alignment problem remains unaddressed, you will ultimately start to lose business to competitors with better distribution networks.
Quantifying that cost is of course difficult, if not impossible. If you actually lose a customer, you might be able to calculate the value of lost business. It’s less easy to fathom how many and by how much those customers who remain, might have increased their business with you if their needs were being better met.
Nevertheless, any loss—or even failure to gain—is detrimental to your business and can assuredly be counted as a wasteful cost of distribution network misalignment.
Now What Do You Think About Distribution Network Misalignment?
You don’t need to be a genius to understand the seven “costequences” of a poorly aligned distribution network, and this post is not intended to be revelatory in that regard. As a supply chain professional, you surely know the costs which need to be managed and kept under control.
However, overlooking the cost impact of distribution networks is a common error made by logistics operators, as is underestimating the importance of regular network reviews and optimisation modeling.
Scan through this post once more, and just look at all the costs a misaligned network might generate. Consider how they might mount up over one, two, three, or more years of operation.
Finally, take a moment to ask yourself, “do my colleagues and I really know how well-aligned our company’s distribution network is today?” The answer could be a step towards network cost savings of up to 15%, or perhaps even more.
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