To centralise or decentralise your distribution centres? A business case for both from CEO Leigh Williams.
October 5, 2020
By Leigh Williams, CEO and founder of eStore Logistics
Many bricks and mortar retailers are reducing their floor space and converting stores into fulfilment centres. As consumers demand a faster, more efficient online shopping experience, there is a trend emerging toward dark stores and decentralised ‘micro’ fulfilment centres. Leveraging automation, this model has the benefit of goods being located considerably closer to customers, reducing delivery times and cost. It is, however, not all good news. This strategy can increase logistics costs and reduce efficiency gains provided by large, centralised distribution centres. Before we consider both cases, let’s take a look at the trends influencing this shift in Australian retailer business model.
E-commerce was already rising prior to the pandemic: Australia Post data shows online retail sales were growing 20 percent annually and were projected to reach $33.2 billion by the end of 2020. COVID-19 has catalysed this shift; bricks and mortar retailers are being forced to adapt to government restrictions and consumers are transitioning and in many cases embracing the convenience of online retail.
Recent research from McKinsey reveals that 75 percent of the digitally-shy Gen Xers claim they’ve shopped online in the past two weeks and of those, more than 40 percent have increased general shopping habits amid COVID-19. Similarly eStore Logistics’ own data shows year-on-year increases in customer orders of 73 percent in April, 99 percent in May, and 81 percent in June and 87 percent in July.
Understanding the different warehousing models
- Under the centralised model, inventory is stored in a minimal number of large, centralised, optimised warehouses. This is a cost-effective option for retailers, who pay consolidated fees to third-party logistics providers (“3PLs”) or rent to industrial property landlords. Retailers also enjoy economies-of-scale savings on their investment in people, systems, processes and technology.
- A decentralised model aims to store goods in many locations, closer to the customer, to fulfil orders faster and at a lower delivery cost. This can increase customer satisfaction and drives return purchasing behaviour. Consumers may receive their order split across multiple deliveries rather than the preferred ‘single delivery’.
Bricks and mortar stores as micro fulfilment centres
Understandably, some bricks and mortar retailers with an ecommerce offering have been considering how to leverage their store locations to implement a decentralised warehousing strategy. With the recent ecommerce surge and increased consumer expectations, retailers are hurrying to reduce floor space and convert stores into fulfilment centres to have goods as close as they can to consumers.
Any retailer with an online offering considering a decentralised model should carefully consider whether scenario modelling supports these changes to their distribution model taking into consideration factors such as; optimal stock keep unit (SKU) holding depth and breadth, fulfilment complexity, inventory management, rent differential, logistics costs, working capital requirements and delivery speed.
In many cases, the most optimal outcome is rarely delivered through a network of micro fulfilment centres.
CHOOSING A WAREHOUSING MODEL THAT SUITS YOUR BUSINESS
The best inventory management and order fulfilment approach depends entirely on the retailers’ needs, business models and objectives.
The centralised model
Inventory Profile: Retailers with a wide SKU range, and shallow quantities on hand
Large centralised distribution centres are most suited to retailers that have large product ranges, hold small quantities of each product on inventory and each product is of low shipping weight. Significant benefits can be gained through the use of centralised distribution centres, including but not limited to; reduced logistics costs, simple inventory management, an optimised workforce, among many others. For those who engage a 3PL, the economies of scale you might gain, including capability in robotics and other recent technological advances may outweigh the cost and complexity of running your own operation.
- If a retailer with the same profile were to decentralise, they would be forced to deploy scarce capital to duplicate inventory holdings across multiple locations.
- Further to the above, there would also be a requirement to manage the increased inventory complexity, adding to the costs of supporting resources.
An example of a retailer with this profile is an apparel brand which sells many products in various sizes, colour and designs.
The decentralised model
Inventory Profile: Retailers storing large volumes of only a few distinct, fast-moving items Inventory
Decentralised warehousing is better suited to businesses such as a bed-in-a-box retailer that sells only a few types of bulky products like mattresses, but manufactures them in large quantities.
- The item itself is large and expensive to ship long distances, but typically a retailer with this profile would have deep inventory holdings in each product and it would be cost effective and not overly complex to distribute quantities of each product across multiple warehouses.
- As the centres are dispersed, the retailer is able to ship the product from the warehouse closest to the customer, saving in delivery fees and offering a convenient service to the customer.
Crucially, however, retailers using decentralised order fulfilment may find their costs increasing if they get their inventory dispersion wrong leading to inefficient deliveries. For example too much inventory located in Perth which then has to be sent to customers in Sydney or Melbourne. For anything outside of a narrow SKU range, duplication of stock also means higher warehousing costs and manpower, technology and logistics investment don’t benefit from economies-of-scale. It also makes stock forecasting very complicated, and even small variances outside of the margin for error can have expensive consequences.
The hybrid model
Inventory Profile: A combination of both.
In a select few cases, there may be value in a hybrid model, where the majority of stock is held and distributed centrally and a select, small number of SKU’s distributed via decentralised distribution centres.
An example of a retailer with a profile that may lend itself to this model is an online retail variety store that holds a combination of both stock profiles. For a select number of bulky, fast-moving SKU’s, a retailer with this profile may choose to store and distribute these separately to the bulk of the other items, when the reduced cost to ship to consumer outweighs the efficiency of its’ central distribution centre.
Rent and labour market costs vary from state to state. For example Sydney typically has higher industrial rent and a tight labour market compared to Melbourne. I encourage retailers to model the potential costs to hold bulkier, high-value goods in multiple locations in comparison to the cost of freight between states.
Knowing which model works for you
There is no one size fits all approach to logistics and warehousing. In order to deliver a great customer experience, retailers must establish a strategy that suits their business profile which reduces delivery times and minimises costs. This can be achieved using decentralised order fulfilment in circumstances where the retailer inventory profile makes sense. For retailers with wide SKU ranges, the reality is, this approach will be expensive, complex and a risk to the operation.
For most small to medium online retailers, cost effective and fast order delivery and customer satisfaction can only be achieved through advanced centralised logistics. Warehouse robotics, only just taking off in Australia, cost effectively enables same-day-order fulfillment as late as 4pm. The centralised model also means less commitment to expensive inner-city commercial space and in eStore Logistics’ instance, for example, warehouse space can be dialled up and down as customers require, so retailers only pay for space they need.
Positive customer experience is at the heart of every successful retail business model. Determining the optimal approach will be rewarded with stronger profit margins, brand loyalty and an ability to scale sales with the significant opportunity that is online retail.