VOLUME 24 •• NUMBER
NUMBER 77 •• JUNE
jUNE 2009
2009
2009
are quite as flexible as they seem. Management may be re- The Importance Of Inventory Turns
luctant to eliminate experienced workers, particularly
when they will be needed for a coming busy season. The Because storage costs are calculated on a monthly ba-
same is true for forklift trucks and other materials han- sis, the total cost of storing an item depends on how long it
dling equipment. Therefore, the primary risk in control- will be in the warehouse. In the past, each unit received
ling costs is the rate of utilization. for storage had an anniversary date with renewal storage
charges added each month afterward. Later billing sys-
Errors represent another unknown risk. People make
tems were designed to simplify the clerical task by charg-
mistakes, which may result in product damage and errors,
ing a half month for items received after the 15th of the
or shipping errors.
month, and a full month for everything in storage on the
Just as the insurance underwriter factors in the risk of first day of the succeeding month. Regardless of the sys-
loss, the warehouse operator must make a realistic esti- tem used, an inventory that turns 24 times per year should
mate of risk costs. Risk may be expressed as a percentage cost less to store than one that turns six times per year. For
of total warehousing costs. It should be based on past ex- that reason, the inventory turn rate is a critical data point
perience. Methods to reduce risk should be explored. in creating storage prices.
The simplest way to calculate the risk factor is to in-
clude it in the size of the markup. Many time and material The “Make Or Buy” Factor
agreements have a low percentage of profit, but the unit
Nearly all services available from a logistics service
pricing agreement must factor in a higher profit percent-
provider can be replicated by an internally managed pro-
age that reflects the substantial risk of changing volume.
ject. The buyer who knows the amount of space needed,
As you contemplate the risk factor, consider the posi- and has estimated the number of people required to staff
tion of the buyer. With a time and material agreement, the the operation, should be able to simulate the
buyer agrees to pay for all space and labor that is used, “do-it-yourself” cost of providing comparable logistics
which often includes the rent for a building that is dedi- services. This cost is then compared with the prices of-
cated for the buyer’s use. In contrast, the buyer of a unit fered by a logistics service provider. In this situation, the
price agreement pays only for services that actually are risk factor is critical. The do-it-yourself option is full of
used. Expansion and construction can be challenging, as risk, unlike a unit price agreement that provides maxi-
well as costly. mum flexibility because the risk is absorbed by the logis-
A good analogy is the difference between a hotel and an tics service contractor.
apartment. When you stay in a hotel, the price per square
foot of space occupied is higher than the cost of leasing an Living With Hurdle Rates
apartment. You pay the premium because you want the When your company makes an investment in logistics
flexibility of occupying the space only on the days you facilities, financial managers want to know about the re-
need it. While the apartment may be cheaper, you pay for turn on investment. Hurdle rate reflects the minimum per-
it whether or not it is in use. centage of investment return that is acceptable for your
Developing a Handling Price company. If you choose the “do-it-yourself” option, your
A building block approach, using the categories of return on investment will be based on the dollars saved,
warehousing costs included in this article, can be used to rather than the cost of contracting the service to another
develop an hourly selling price. First, all of the costs listed party. Yet, you must recognize the substantial risk of do-
in section I, Handling, are totaled. Next, a portion of the ing it yourself, then compare it to the employment of an
costs in section III, Operating Administrative Expense, independent service provider.
and in section IV, General Administrative Expense are
added to direct handling expense, in order to develop a Simulating A Logistics Service Provider
burdened handling expense. An additional percentage of Some private warehouse operators treat their opera-
profit is added to develop a handling sales price. This fig- tions as if they were public warehouses. Transfer costs for
ure is divided by the hours billed, to convert the figures internal storage and handling prices are determined, and
into a handling fee per man-hour. While you may not in- the warehiouse manager is held accountable for profitable
voice your customers by the hour, the hourly fees can be operation at the established rates.
used to check the validity of current pricing.
Thomas W. Speh is Associate Direc-
Creating A Storage Price tor of MBA Programs at Miami Uni-
A similar building block approach is used, but the re- versity. He also holds a part-time
sult is expressed in square feet, rather than hours. Since position with CSCMP, as Director
storage costs increase with time, this storage fee is ex- of Strategic Initiatives. Dr. Speh re-
pressed on a per month basis. tired from full-time teaching at Mi-
The first step is to total all costs listed in section II, ami's Farmer School of Business in
Storage. Following the handling example described in 2008, where he taught courses in
this article, a portion of operating and general administra- Logistics and Supply Chain Man-
tive expenses must be added, in order to develop a bur- agement for 35 years. He has
dened storage expense. Then, a desired profit margin per- woorked on consulting projects in a
centage is added to create a price per square foot per variety of supply chain areas with
month. That price determines the storage rate per unit. many different firms.
A FORM FOR WAREHOUSE COST CALCULATION
II. STORAGE (continued)
I. HANDLING
3. Insurance . . . . . . . . . . . . . . . . . . . . . $________
A. Labor 4. Building maintenance . . . . . . . . . . . . $________
1. Direct payments: 5. Other . . . . . . . . . . . . . . . . . . . . . . . . . $________
a. W ages . . . . . . . . . . . . . . . . . . . . $________
b. Overtime . . . . . . . . . . . . . . . . . . $________ B. Grounds
2. Fringe benefits 1. Lawn and landscaping maintenance . $________
a. Health insurance . . . . . . . . . . . . $________ 2. Parking lot maintenance . . . . . . . . . . $________
b. Pension . . . . . . . . . . . . . . . . . . . $________
c. Life insurance . . . . . . . . . . . . . . $________ C. Storage equipment (racks and/or shelving)
d. Uniforms . . . . . . . . . . . . . . . . . . $________ 1. Depreciation and interest . . . . . . . . . $________
e. Other . . . . . . . . . . . . . . . . . . . . . $________ 2. Maintenance . . . . . . . . . . . . . . . . . . . $________
3. Compensated time off
a. Vacation . . . . . . . . . . . . . . . . . . $________ D. Utilities
b. Holidays . . . . . . . . . . . . . . . . . . $________ 1. Heat and/or temperature control . . . . $________
c. Sick leave . . . . . . . . . . . . . . . . . $________ 2. Lighting . . . . . . . . . . . . . . . . . . . . . . $________
d. Jury duty . . . . . . . . . . . . . . . . . . $________
e. Funeral leave . . . . . . . . . . . . . . . $________ E. Security
f. Other . . . . . . . . . . . . . . . . . . . . . $________ 1. Sprinkler and other
4. Taxes fire protection systems . . . . . . . . . . $________
a. FICA . . . . . . . . . . . . . . . . . . . . . $________ 2. Electronic burglar alarms . . . . . . . . . $________
b. W orkers compensation . . . . . . . $________ 3. Guard service . . . . . . . . . . . . . . . . . . $________
c. Unemployment compensation . . $________
d. Other . . . . . . . . . . . . . . . . . . . . . $________ F. Pest control
5. Temporary labor
6. Development costs G. Other facility expense
a. Training . . . . . . . . . . . . . . . . . . . $________
b. Education allowances . . . . . . . . $________ III. OPERATING ADM INISTRATIVE EXPENSE
c. Other . . . . . . . . . . . . . . . . . . . . . $________
A. Supervisory salaries . . . . . . . . . . . . $________
B. Handling equipment
1. Lift trucks and attachments B. Clerical salaries . . . . . . . . . . . . . . . $________
a. Rental . . . . . . . . . . . . . . . . . . . . $________
b. Depreciation and interest . . . . . . $________ C. Labor purchased from
c. Maintenance . . . . . . . . . . . . . . . $________ staffing services . . . . . . . . . . . . . . $________
d. Motor fuel or electricity . . . . . . $________
2. Conveyors D. Office and data processing equipment
a. Depreciation and interest . . . . . . $________ 1. Depreciation and interest . . . . . . . . . $________
b. Maintenance . . . . . . . . . . . . . . . $________ 2. Software . . . . . . . . . . . . . . . . . . . . . . $________
c. Electric power . . . . . . . . . . . . . . $________ 3. Maintenance . . . . . . . . . . . . . . . . . . . $________
3. Pallets 4. Training . . . . . . . . . . . . . . . . . . . . . . $________
a. Purchase or replacement costs . . $________ E. Office maintenance . . . . . . . . . . . . . . $________
b. Repair . . . . . . . . . . . . . . . . . . . . $________ F. Communications costs . . . . . . . . . . . $________
G. Legal and professional . . . . . . . . . . . $________
C. Other handling expenses H. Taxes and licenses . . . . . . . . . . . . . . $________
1. Detention/demurrage I. Travel . . . . . . . . . . . . . . . . . . . . . . . . $________
2. Recouping damaged product J. Insurance and claims . . . . . . . . . . . . $________
3. Trash and/or snow removal K. Losses due to damage, shortages
4. Maintenance of loading docks and related and errors . . . . . . . . . . . . . . . . . . . $________
equipment
IV. GENERAL ADM INISTRATIVE EXPENSE
II. STORAGE A. Executive salaries . . . . . . . . . . . . . . . $________
B. Executive office expenses . . . . . . . . $________
A. Facility C. Selling and advertising expenses . . . $________
1. Rent, or depreciation and interest . . . $________
2. Taxes . . . . . . . . . . . . . . . . . . . . . . . . $________
Measurement of risk, including fire protection, and the
risk of flood, windstorm, and earthquake is nearly as
important. Is there a contingency plan if a natural disaster
wiped out the warehouse?
When Does Mechanization Cost and availability of labor is of varying importance,
Make Sense? since some warehouse operations are more la-
bor-in-tensive than others.
The short answer is that the investment is sound when Finally, tax incentives are a good indication of how
payback is reasonably sure, and short. Equipment ven- badly a community wants to attract new warehouse opera-
dors are taught to demonstrate payback, and any buyer tions. In some cases, they can provide significant savings.
who does not ask the salesman about return on investment
is asking for trouble.
Mechanization always has risks, the biggest of which
is that equipment won’t function as promised. Another Company Statements
risk is a lack of flexibility, and warehouse mechanization In addition to financial statements, many companies
always has had an inverse relationship to flexibility. To publish written statements to inform employees, custom-
some extent, this has changed with robotic equipment, ers, and the public what they stand for. Company mission,
some of which is capable of reprogramming, or even mov- values, vision and strategy usually are included in the
ing to another building. statement.
Payback also is related to volume, so there is a risk that The mission statement explains why the company ex-
unexpected erosion of volume will increase payback time ists. A values statement describes your beliefs and behav-
far longer than originally estimated. Because logistics iors. Vision tells where you are going and what you want
service providers seldom are able to control volume, to be. Strategy describes your competitive game plan.
mechanization is especially risky for the logistics service Few warehousing companies publish all four state-
provider. ments. As well, many companies publish statements that
Mechanization should save either space or time, and in are so bland and generic that they are meaningless.
rare instances, it may save both; therefore, the greatest op-
portunities are in the most labor intensive warehouse
jobs. These include building or stripping pallets, picking
orders, or handling of less-than-case quantities. Ex-
Form Follows Function
tremely long travel within a warehouse also is a candidate Have you ever asked why your warehouse exists? Why
for mechanization. was it established? Why is it located where it is?
When land is extraordinarily expensive, mechaniza- It is not uncommon to find a warehouse operation that
tion, such as stacker cranes, will enable an unusual has strayed far from its original function. Perhaps a mix-
amount of material to be stored in a modest number of ing center also is being used as a storehouse for slow mov-
square feet. It can be used to eliminate unpleasant, ers. Or, a factory storehouse currently is used to handle re-
hard-to-fill jobs, such as labor within a freezer ware- turned merchandise. If the form has strayed from the orig-
house, or to improve accuracy, such as using bar code inal function, was it because of a careless error, or a delib-
scanning or voice recognition to reduce receiving and/or erate change of policy? In too many cases, the change is
shipping errors. accidental. In nearly all instances, the change of form de-
In the last analysis, measure the risk, and balance it grades the original function of the warehouse. For exam-
against the projected reward. Where possible, share the ple, if it is a mixing center, it should never be too full, nor
risk with the vendor. should it contain the slowest moving items.