I think it is safe to say that the vast majority of companies work hard at minimizing their shipping expense as it relates to carrier charges. If you fall into that large group, then allow me to offer my congratulations. But you would be sadly mistaken if you stopped there, thinking you have minimized your shipping expenses. Have you given thought to how many distribution centers (DCs) your company needs? Or in what cities they should be located? And where, in the selected cities, should a DC be located?
How should you tackle this complex problem? The first step is to understand your companys business strategy as it relates to customer service. If your company markets next day or second day delivery of your products, youll either need many DCs placed throughout the country, or spend a bundle on expedited delivery. However, if timely service is not a requirement, then standard ground service is acceptable and one DC may suffice.
There are two basic underlying forces to consider: fixed and variable costs. Fixed costs include items such as building, land, taxes, salaries and wages. Variable costs are the expenses of operating a private fleet or the dollars paid to carriers for transportation service. The more DCs operated, the higher the fixed costs and the lower the variable costs. Fewer DCs result in lower fixed costs and higher variable costs. Your accounting department can help determine these quantitative measures. Qualitative issues such as the available labor pool, prevailing labor rates, highway networks and carrier on-time service levels are other important areas for consideration. Youll need to develop your own internal ranking system for these.
Once you have all of the vital information, the time has come to select a model to conduct the analysis. There are three approaches to take: develop a computer model using in-house expertise, purchase one of the many available packages or outsource the analysis. Whatever the choice, the person solving your problem will be using something called network optimization, and there are various types of models available. Each type has its own specialized use. Select one that effectively solves your problem. For example, an uncapacitated optimization model is not a good choice if your DCs have a fixed daily output because it will not consider capacity as a constraint. Youll need to understand the limitations of the model you select.
There are two problems to be solved. First, how many DCs are needed and in what cities should they be located (macro); and, secondly, where, in the selected cities, should a DC be located (micro)? The macro problem must be solved before proceeding to the micro analysis.
Lets assume you only desire one DC. The first step is to construct a demand profile of your shipping history by origin and destination ZIP Code. The demands will be used to define a center of gravity, a point of equilibrium that defines where all of the pull of the demands cancel each other out. Next, input the demand profile along with the fixed and variable costs into the model. Run the model to identify the best location.
At this point, I recommend doing a sensitivity analysis. After solving for the best site, run the model again to find the second and third best site. Sometimes the difference is very small, and these sites should not be discounted yet! List all potential cities and use your qualitative issues to rank them.
The micro analysis addresses where, in a selected city, the DC should be located. First, divide the metro area into grids. For each grid, calculate the transportation costs using the highway network and identify the routes that inbound and outbound shipments travel. (If you do not have your own fleet, ignore this step since carrier transportation costs will be the same within a given metropolitan area.) Next, identify the fixed costs by using information obtained from chambers of commerce, economic development centers and local governments (land, tax, utilities or lease payments). A commercial real estate firm can also be contracted to assist in this area. Finally, rank the feasible sites using all costs and the qualitative measures.
Identifying the optimal number of DCs needed and their site selection are crucial to your companys long-term success. Using a structured, proven methodology simplifies a seemingly complex and intimidating endeavor, and ensures your companys expenses are minimized for many years to come.
Joe Loughran is President of SmartTran, Inc. and an expert in small package pricing and carrier rate analysis. Contact him at 724-934-0626 or at loughran@smarttran.com.
