Background
As the director of distribution network studies over the past 20+ years, client leadership will ask “what cost element in my supply chain will drive the distribution center locations?” At least for the manufacturing industry (really every industry except wholesale distributors and food service providers), my experience in distribution network modeling leads me to “inbound freight most probably.” Most are surprised at that answer initially but understand once the study is completed. There are certainly notable exceptions, however no other factor is the best predicter of the DC location(s).
What about Delivery Freight?
All supply chain expense matters and will influence DC location – just not to the same extent. Any professional supply footprint study is accompanied by a MILP model that can trade-off various cost elements to determine the least delivered cost solution under constraints. Though the total delivery costs of freight will rise or fall as the DC moves, the variation is less extreme than inbound freight. Additionally, this is still true despite the fact that delivery freight has smaller shipment sizes than inbound and thus a higher cost per unit basis. Take, for example, outbound parcel shipments which can average $0.25 to $0.35 per lb for ground shipments with UPS or FedEx. Alternatively, inbound freight in full truck load quantities can be less than $0.10 per lb. Many in supply chain leadership positions think that the majority of the spend being in the delivery freight bucket would be all that is needed to determine a minimum cost DC location. NOT TRUE!! While truckload carriers charge a freight rate based on distance traveled, the parcel carriers are using a zone-based formula, with “zones” that cover sometimes hundreds of miles in which the price per lb is constant until a new zone is reached. Thus, since truckload freight has a linear relationship to distance, 50% more miles away from a source will increase the freight by 50% per load. Alternatively, a 50% reduction in the distance from DC to the customer could get a much lower percentage reduction in freight cost.
Further Exacerbating the Issue has been Consolidation of Source Points
Over the recent decades, companies have been enhancing margin (correctly!) by evaluating supply chain models that suggested consolidating factories, vendors, and co-manufacturers to gain economies of scale, enable larger batch sizes, better absorb overhead, maintain full truckload shipment sizes, and mitigate capital outlay. Since inbound freight is typically a smaller component of the total COGS, the total cost models would show there was a net benefit for sourcing footprint consolidation even with inbound freight increasing. Implementing these sourcing consolidation made it increasingly financially painful for DC replenishment freight cost bucket to be closer to larger customers and further away from significant source points that make 15%+ of demand. Even worse, as any source point produces 30%+ of demand (even in small town USA), the supply chain modeling software will tell you that attaching a warehouse to the factory is least cost in terms of total freight expense. Said another way: driving by your customers on the replenishment leg is going to erode margin.
What if my Company has a majority of delivered pricing for inbound shipments?
This component CANNOT be ignored when making DC location decisions. Your company is paying the freight indirectly, whether or not freight is delineated on the invoice. At a minimum, use your companies’ freight rates (per mile) and/or tariffs to estimate what amount the vendor is paying for freight to quantify if there is a significant savings opportunity (or not) if a DC location is moved or added. It may require a re-negotiation with the suppliers to realize the savings (via a change in the purchase price). Alternatively, your company could also realize the savings by changing the freight terms to collect from delivered and managing the inbound freight component directly. How this situation is modeled is a trade secret, however it is important to predict the impact of inbound supplier/vendor freight to any change in number or location of DCs in your network.
Conclusions
For most industries, such as manufacturing, retail, pharmaceutical, chemical, et al, inbound freight may determine the least net cost DC locations more than any other single cost component.
—Craig Vorse, St. Onge Company
