Consolidation warehouses add efficiency

Recent proposals to restructure the logistics infrastructure for wholesale grocers and retail supermarket chains offer the possibility of cutting inventory throughout the supply chain while reducing costs and improving productivity for distributors.

As practiced by most wholesalers and retail operators, the supply chain contains at least four links starting with manufacturing plants. Usually unable to sell goods as fast as they are produced and unable to store all inventory at the manufacturing site, most manufacturers ship their working inventory downstream in the supply chain to internal distribution centers or public warehouses for storage and subsequent shipment to wholesale customers. Wholesale grocers and retail chains, in turn, store product in their own warehouses until it is ordered by stores, at which time it is handled again in almost exactly the same manner as it was handled in the manufacturer's distribution center. Product in wholesale distribution centers falls into two categories — fast moving items in constant demand by stores and slow-movers that sell consistently, but at a slow pace and low volume. Some of the slow-movers sell at the rate of less than a pallet load per week at fairly active wholesalers.

The result is that most wholesale distribution centers contain excess inventory. Fast moving inventory is stocked in large quantities so that it is always available for shipment. At the same time, wholesalers usually have excess slow-mover inventory, because manufacturers require purchase of a minimum amount that often exceeds short-term demand. Both factors add to total system inventory and inflate holding costs as well as requiring additional storage capacity. Adding to this inefficiency is the proximity of the warehouses. In the Northeastern US, manufacturer and wholesaler warehouses are clustered together with about 35 warehouses in the area, often within 10 miles of one another.

The traditional distribution chain almost requires inefficient operation. It is built on the concept of duplicate storage facilities between the manufacturer and the consumer and on duplicate labor practices at each link of the chain.

From the manufacturing side, a great deal of the emphasis on cutting costs and improving the supply chain comes from a concern about the rising power of Wal-Mart. Ten years ago, Wal-Mart played almost no part in the grocery business. Today, Wal-Mart comprises as much as 35% of the volume for some grocery manufacturers. One way to help stem that potential for bare-knuckled power in the market is for manufacturers to find ways to help small- and medium-sized retailers and wholesale grocers remain in business as competition to Wal-Mart.

To survive against the Wal-Mart onslaught, retailers and wholesalers must find ways to cut expenses. For instance, Wal-Mart has an advantage of about 8% in operating expense as a percentage of sales at 18% compared to Safeway's 26%. Some supermarket analysts say that customer service at traditional chains can offset Wal-Mart's cost advantage, but others suggest that the retailer that offers the best price advantage to consumers always wins. The results should be relatively easy to measure with Wal-Mart in the process of opening 200 of its grocery-selling supercenters in 2003.

One recent concept for supply chain simplification and cost reduction is the idea of consolidation warehousing. In this concept, manufacturers move away from multiple warehouses for downstream storage and combine their inventories with that of other manufacturers in huge warehouses that take the place of internal distribution centers or third party logistics providers. This concept is a particular favorite of Jack Haedicke, president of the Arena Consulting Group in Eden Prairie, Minnesota.

It is called consolidation warehousing, Haedicke says, because these warehouses perform functions otherwise found in manufacturers' distribution centers or at wholesale grocery warehouses. The consolidation warehouse is a third party storage and consolidation point for the manufacturers and a storage and order selection facility for wholesale grocers and retail supermarket chains.

The concept calls for multiple manufacturers to combine their output into just a few consolidation warehouses instead of placing product in corporate distribution centers or individual public warehouses. In turn, the consolidation warehouses would serve multiple wholesale grocers and supermarket chains much like public warehouses now provide load consolidation.

The difference is the scale of the operation. With the consolidation warehouse serving multiple wholesalers and chains, manufacturers could ship full truckloads, often truckloads of a single product to the warehouse. On the other side of the equation, the consolidation warehouse, pulling product from a wide array of manufacturers, could build full truckloads for shipment to wholesaler and chain distribution centers. In two best-case scenarios, Haedicke says, consolidation warehouses would select store-ready orders and ship them to distribution centers for cross dock delivery within hours. If store orders are large enough, full truckloads could be shipped directly from the consolidation warehouse to individual stores, he says. Another possibility would be to have food distributor private fleets pick up completed orders from the consolidation warehouse for direct delivery, bypassing the wholesale distribution center completely. Some chains already working with consolidation warehouses station their own order selectors at the warehouses to generate store orders. Taken to its logical extreme, some wholesalers could do without distribution centers entirely, Haedicke says.

The first consolidation warehouse, Interstate Frozen in Indianapolis, Indiana, opened in 1991, primarily to serve Kroger. The idea was to make the logistics functions of several mid-tier suppliers to Kroger more efficient. Others include ES3 established in York, Pennsylvania, by stockholders in C & S Wholesale Grocers; ServiceCraft, an independent logistics provider in Buena Park, California; Foxboro Terminals in Foxboro, Massachusetts; an Americold Logistics operation in Atlanta, Georgia; and the Advantage Logistics arm of Supervalu.

To succeed, these warehouses must be huge, a minimum of at least one million sq ft, Haedicke says. For instance, the facility operated by ES3 is a one-million-sq-ft storage tower, one of a reported total of eight towers scheduled to be built at the site. As a result of the massive scale of consolidation warehouses, only a few locations are suitable. Haedicke lists 10 possible locations including the Pacific Northwest, Northern California, Southern California, the mountain states, the central Midwest, Texas, the Eastern Midwest — probably Indiana or Ohio, New England, the Northeast, and Atlanta. Once the push to enter consolidation warehousing gets underway, the window for entry will close fairly rapidly, probably within four to five years, he says.

While consolidation warehousing has yet to become a major force in the food distribution industry, the theory offers a number of advantages for manufacturers. The first of these is the ability to forecast demand and schedule manufacturing more accurately. In the current environment, manufacturers offer special deals at the end of fiscal quarters to make sure that the company meets its sales goals. The result of the low-priced deal is that a wholesaler buys heavily at the end of a quarter and starts the next quarter with significant holdover stock. Production at the manufacturer slows until the excess is sold. Maintaining a constant stock level at a consolidation warehouse should help stabilize this scheduling problem.

In addition, with a smoother production schedule, manufacturers should be able to ship more production directly from the plant rather than having to rely on outside storage or internal distribution centers. This should allow increased consolidation of outbound freight in lower-rated truckloads along with reduced transportation costs for unloading partial shipments and waiting time at customer docks, Haedicke says.

On the wholesaler and retail chain side of the equation, consolidation warehousing can move nearly all slow-movers out of the wholesale distribution center, increasing inventory turns for all other products. This reduced inventory provides a large one-time cash influx and a total operating expense reduction that could be as high as 30 cents per case, Haedicke says.

The cost per case for handling and distribution varies widely. The 2002 Food Industry Distribution Center Benchmarking Report published by the Food Distributors International association, now a part of the Food Marketing Institute, says that the average cost per case for high volume wholesale grocers is 57 cents per case. The same study says that retail chains have an operating cost of 43 cents per case. Haedicke says that he has seen cost per case figures as low as 23 cents and as high as $1.10 with an industry average of 65 cents per case.

Operating with store-ready cross dock orders reduces handling costs and labor requirements in the wholesale distribution center as well as reducing waiting time at the dock for carriers delivering inbound freight. With the consolidation warehouse holding significantly more inventory than a wholesale distribution center, out-of-stock problems disappear with a resultant increase in profit and in customer satisfaction.

Consolidation warehousing also offers wholesalers and retail chains the opportunity to grow at much lower levels of capital investment. With the majority of inventory in the custody of a third party, wholesalers and retailers can increase sales without building expensive new facilities. Growth becomes dependent on increasing the amount of cross dock and direct store delivery traffic, Haedicke says.

Questions arise about where title to goods passes from manufacturer to distributor in a consolidation scenario. Apparently that transfer of title can occur at any point in the chain just as it does now. This can be at the manufacturer's dock, at the consolidation warehouse, at the point of shipping from the consolidation warehouse, or at delivery to the supermarket. At some chains, studies are underway that will not pass title to inventory until the consumer makes a purchase.

One thing is certain about the change of ownership, Haedicke says. If the title passes while inventory is in the consolidation warehouse, the purchaser will avoid the cost of unloading, counting, and stocking the wholesale distribution at transfer.

Convincing manufacturers and distributors to adopt the concept of consolidation warehousing will require some basic changes in food industry thinking. For the concept to work, the warehouses must be exceptionally large and must be able to serve multiple manufacturers and multiple distributors. The change will not be as great for manufacturers, because many already are accustomed to sharing storage space with other manufacturers at public warehouses. For wholesalers and retail chains, the change will be more profound, requiring an agreement to cooperate with competitors more than in the past. However, inventory management through consolidation warehousing will remain completely proprietary for each participant, and the concept may be hard to accept, Haedicke says. However, this cooperation will have the benefit of setting the same inventory management cost structure for all competitors in the system, he says.

Jack Haedicke is president of the Arena Consulting Group in Eden Prairie, Minnesota. Arena CG specializes in cost accounting and supply chain activities such as streamlining the production and distribution of products. It was founded by Haedicke in 2000. He has been executive vice-president and chief financial officer of a Fortune 500 company, executive vice-president and chief operating officer for One-Source, vice-president of finance and ECR for Draft Foods, director of activity based costing at Coca-Cola, and controller of manufacturing for the Hughes Aircraft Company. Haedicke holds a bachelor's degree in biochemistry from Michigan State University, a master's degree in human resources management from Central Michigan University, an MBA from the University of Michigan, and doctoral coursework from the Drucker Center at Claremont University.

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