Where Should You Locate Your New Warehouse?
01/11/2017
Phillip Riback - Vice President for Development
My neighborhood guitar store closed the other day after 17 years in New York’s Lower East Side. I was speaking with the owner who told me that more and more of their sales were coming from their website. And a couple of the local music venues had closed with rising rents decreasing foot traffic for the guitar store. Of course, as rents rise, the artists and musicians who had anchored the neighborhood are being priced out and are moving to less expensive neighborhoods further decreasing foot traffic. So they decided to close the brick and mortar store and sell online as they look for a new location to open sometime in the next year. But where is the best place for them?
As the distribution of the customer base, traffic patterns, and routes change, so does the optimal location for a warehouse. This is a classic branch of computational geometry, analogous to the salesman problem. Typically, it is assumed that the fixed cost for each location is equal. Using sophisticated mathematical techniques, the location with the lowest sum of distances or the lowest maximal distance is calculated and presumed to be the optimal location for the facility. This is great for those corporations with their own fleet, but for the rest of us, several of the base assumptions in this model however are wrong:
- The fixed cost of each warehouse is the same
- The variable cost of shipping is directly related to mileage
- Shipments are evenly distributed
Fixed Cost of Each Warehouse
The major components of the fixed warehouse cost are real estate, labor, utilities and taxes. These may vary greatly between locations, even if they are located nearby, but in different jurisdictions. They say the three most important components of real estate cost are location, location and location. We have all seen differences in pay scales and local taxes between one locale and another close by. That can be further complicated by local tax breaks designed to entice business. Yet the fixed cost for each location can be determined with reasonable certainty.
Shipping Cost is Directly Related to Distance
There is certainly a correlation between mileage and shipping cost, most evident with truckload mileage rates. This assumption falls apart however with truckload flat rates by state. Imagine a warehouse in Buffalo, NY, sending shipments to Cleveland and Cincinnati, OH, with the same flat fee. The distance to Cleveland is 190 miles, yet to Cincinnati is over twice that at 440 miles. So the cost per mile to Cincinnati is less than half that to Cleveland. Similarly, Cleveland and Cincinnati are in the same parcel zone, again making the farther shipment less than half the cost per mile of the closer one. Also, for LTL shipments, the base rate for those two shipments only differs by about 10%, so unless the discounts are markedly different, the distance is not the primary consideration in cost.
Shipment Distribution
The above-noted model assumes an even distribution of shipments, ie that each destination receives the same number of shipments in the time period. In practice, this is not seen. A lot more snow shovels are shipped to Buffalo, NY (average annual snowfall 93 inches), than Richmond, VA (average annual snowfall 12 inches), yet they both need them. This can be accounted for in the models, but usually is not.
The equations solve for an interesting set of numbers, but not what a shipper is interested in, namely the cost. To accurately determine optimal warehouse location, one must take into account all of the above factors. Specifically, the fixed cost for each location and the variable freight costs based upon the company’s freight history and anticipated changes in routing patterns. Saving $1 million in rent is not going to offset a $2 million rise in freight costs. Rerate actual freight as if it were shipped from the new location to understand the true impact of freight expenses. Do NOT assume that freight costs will not change. Look at ALL of the parameters before making decisions you will have to live with for a long time.
I hope the guitar store opens up just on the other side of the Williamsburg Bridge so I can get there by bicycle. I want to check out some of the new boutique effects pedals and they have the best selection in the city.
Next Post - Control Your Inbound Freight
7/19/2016 - Keep an Eye on Your Freight Costs
