Network Evaluation Approach

Over the past few years we have performed detailed facility and transportation network assessments for our clients and trends keep emerging that greatly affect the methods we use to perform these assessments – The impact of inbound freight. It was always the outbound transportation, service levels and facility fixed and variable costs driving the optimal (centroid point) and most cost effective selection. Now, for our clients with heavier import volumes, we are seeing a major change. The constant increase in energy and ship/rail capacity issues still drives the inbound shipping costs ever higher. This has moved the import products into a major criteria point in the final site selection.

Although many things are often considered when evaluating a company’s distribution network, there is usually focus within 3 major factors:

• DC operating costs and inventory investment
• Outbound transportation expenses (to stores or customers)
• Customer service levels

The number of distribution centers (DCs) and their optimal location is often selected when total DC/inventory and outbound transportation costs are minimized at the inflexion point (centroid point) bounded by the green and gray shaded areas. The primary exception is when customer service standards require more DCs to service demand within a set time window from when orders are placed.

Other Considerations will affect the outcome and should be included

A number of other factors should be considered either within a linear programming network model or in separate analysis:

1. Slow moving inventory and minimum order quantities with high inventory investment: Manufacturers of repair parts often require minimal order quantities that would result in high inventory carrying costs and space issues if they are carried at all of a company’s DCs. Consequently, a central DC might make sense for slow moving items purchased from other manufacturers, especially for large consumer product firms or manufacturers of complex equipment.
2. Future growth potential: Companies should evaluate space requirements based on expected sales growth over the expected lease term.
3. Existing leases: If a company has an existing lease, it may not be able to sub-lease the property to move to an alternate site closer to its customer
4. Labor considerations: Potential severance costs, retraining expenditures, relative labor costs by area, availability of sufficiently skilled labor and stipulations in existing labor contracts should be evaluated.
5. Costs of relocation: If relocation costs are high they might yield a return on investment that is
6. Taxes and tax incentives: Property and inventory taxes can vary greatly by state. Also, states and communities often forgive some or all taxes for a number of years to attract new businesses.
7. Inbound freight: Inbound freight may not be modeled, since it is believed that costs would not vary that much between different scenarios. However, as discussed below these costs are becoming significant, especially for retailers or any industries which have significant import container volumes.

Inbound Freight – Drayage and Fuel Surcharge Increases

We have seen that inbound import freight costs are skewing the results, when modeling the optional centroid point for regional or local DC’s. For example, we recently completed a project for a company that receives more than 60% of their volume via import container and land-bridge across the US. “Greenfield” and other analysis indicated opportunities to relocate one distribution center closer to customers and or stores, those with the most sales and future sales growth. The result was that outbound transportation savings would be significant. However, when adding the inbound import and container volumes and related costs for ocean, drayage and fuel surcharge costs per 40 foot container, we found that in some cases, this exceeded all the outbound transportation savings. The result is that the optimal centroid point modeled for fixed/variable and outbound transportation cost and service levels were greatly moved closer to major ports or land-bridge drop points. Drayage costs certainly became excessive as the centroid point was moved further from the import port of entry. In some cases the centroid point was moved 100’s of miles from its optional point.

We strongly recommend that any industry requiring large import container volumes (retailers and consumer products) keep this in mind when evaluating and modeling their distribution network. As energy and related shipping costs keep increasing, this situation will become even more critical in modeling the “real world” best location RDC/ LDC regions.

Further considerations due to the Implications from the Widening of the Panama Canal By late 2014 or early 2015 the $5 billion Panama Canal Expansion Project begun in 2007, should be complete. Today, “Panamax” vessels with a maximum length of 965 feet and width of 106 feet can fit into Panama Canal locks. These vessels can handle a maximum of 4,500 TEUs (Twenty Foot Equivalent Units). When construction of 2 new lock complexes is completed much larger “Post-Panamax” vessels will be able to traverse the Panama Canal.

The “Post-Panamax” vessel can have a maximum length of 1,200 feet and width of 160 feet. They will be able to transport as many as 12,000 TEUs.

In anticipation of the completion of the Panama Canal expansion, many East Coast or Gulf cities and states are spending millions or billions of dollars to dredge and deepen nearby ports (please see Figure 2 below). In order to handle the larger vessels the following 3 conditions must be in place:

• Channel depth of at least 50 feet
• Cranes large enough to reach all containers
• Docks that can handle the larger cranes

For the first time shippers will be able to ship directly to East Coast and Gulf ports, bypassing the four deep water West Coast ports (Los Angeles, Long Beach, Oakland and Seattle), where intermodal shipments are necessary to points further east. Also, some shippers, importers and retailers want to avoid the heavy congestion in West Coast ports, where warehouse space is limited. Many executives in companies still remember the devastating $16 billion economic loss in 2002 when 7,000 members of the International Longshoremen and Warehouse Union went on strike at West Coast ports. Retailers, importers, shippers,

warehouse distributors and state port authorities began actively looking for alternatives to West Coast ports. It is anticipated that additional options and economies

of scale in handling larger vessels on the East Coast may result in a 10 to 25 percent drop in larger vessels docking on the West Coast.

It is too early to tell the exact consequences of changes in shipping patterns. However, many large retailers, consumer products companies and 3PL logistics firms may want to locate more of their facilities near East Coast and Gulf ports that can handle “Post-Panamax” vessels in the near future. Factors that should be considered include:

• Relative transit times to DCs (West Coast vs. East Coast)
• Costs per container to the East Coast vs. West Coast with intermodal transportation
• Observed changes in shipping patterns and competition by shippers

Conclusions

Things are changing quickly with inbound and import freight costs and options. This is causing major affects in considering the key variables when performing an evaluation of the facilities and transportation network. In addition, most modeling

software tools do not handle inbound transportation options well. In most cases you need to perform the evaluation outside the tool and then input the results into the model, along with the other fixed/variable and outbound transport variables.

As we perform these assessments for our clients, we are continually modifying our methodology, modeling inputs, and options to address these changing conditions. We suggest you do the same so you don’t end up making expensive strategic decisions, with outcomes that do not match the expectations. So far, the effect of the Panama Canal expansion is being debated. Therefore we suggest you model this two ways; either assume your closest Point of Entry is your import source (it will accept larger ships) or look at your 2-3 best points of entry (port, rail head, other) to compare the inbound cost differences.