How many distribution centers (DC’s) does your company need? In what cities should they be located? Where, in the selected cities, is the optimal site? How should you tackle this complex problem?
The first step is to understand your company’s business strategy as it relates to customer service. If your company markets next day or second day delivery of your products, you’ll either need many DC’s, or you’ll spend a bundle on expedited service. On the other hand, if rapid service is not a requirement, then standard ground service is acceptable and one DC’s may suffice.
There are two basic underlying forces to consider: fixed and variable costs. Fixed costs include items such as salaries and wages, building, land, and taxes. Variable costs are the expenses of operating a private fleet and/or the dollars paid to carriers for transportation service. The more DC’s used, the higher the fixed costs and the lower the variable costs. The fewer DC’s, fixed costs are lower and variable costs are higher. Your finance department can assist in determining 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. You’ll need to develop an internal ranking system for assessment.
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 models, or outsource the analysis. Whatever the choice, the person solving your problem will be using something called network optimization. There are various types of network optimization models available. Each type has its own specialized use. Utilize one that effectively solves your problem. For example, an uncapacitated optimization model is not a good choice if your DC’s have a fixed daily output because it will not consider capacity as a constraint. You’ll need to understand the limitations of the model you select.
There are two problems to be solved. First, how many DC’s are needed and in what cities should they be located (macro); and, secondly, where in the selected cities is the best site (micro)? The macro problem must be solved before proceeding to the micro analysis.
Let’s 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’. What is a center of gravity? It is a point of equilibrium that defines where all of the “pull” of the demands cancel each other out. Input the demand profile and 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 so they non-optimal ones should not be ruled out yet. List all potential cities and use your qualitative issues to rank them.
The micro analysis addresses where in the 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 would travel. (If you do not have your own fleet, ignore this step since carrier transportation costs will usually 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 DC’s needed and their site selection is crucial to your company’s long term profitability and success. Using a structured, proven methodology simplifies a seemingly complex and intimidating endeavor, and ensures your company’s expenses are minimized for many years to come.
Joe Loughran
Joe Loughran is President of Parcel Rate Solutions and an expert in the parcel industry. Parcel Rate Solutions is a transportation consulting company offering services in Carrier Rate Analysis and Carrier Agreement Analysis. Joe can be reached by phone at (724) 934-0626 or email: loughran@parcelratesolutions.com.