Rising Fuel Costs Highlight Need for Stronger Distribution System Efficiencies
John Bell (July 2011)

Industrial and consumer goods companies are into recovery in a big way. As the nation's economy picks up steam, firms are rejuvenating their operations. One of the key elements of this rejuvenation is the fine-tuning and upgrading of their supply chain, i.e., the structure through which goods move to market.

Peter Quinn, executive managing director of Global Supply Chain Solutions for Cushman & Wakefield, remarks, "Supply chains have become very critical in the past 10 years as companies compete for market share not only domestically but around the world. With the increased pressures on profitability, one way to improve profit is to optimize the supply chain."

Quinn points out that no two supply chains are identical. "It depends on the company and its moving parts. There are different solutions for different companies," he says. However, there is a common denominator. "All firms live in a competitive environment, so the supply chain has become an essential component. Who can get product to customers quickest and most efficiently?" he asks.

Peter Schultz, executive vice president- East Region for First Industrial Realty Trust, agrees that supply chain focus is on speed of delivery inbound and geared to the most efficient transportation costs outbound. "Stronger companies are taking market share away form weaker ones," he observes.

Anticipating Customer Demand
One important aspect of supply chain operations is to be able to anticipate customer demand. Tim Feemster, senior vice president and director of Global Logistics for Grubb & Ellis, says companies are starting to use store purchase data to drive their supply chain replenishment cycles in an effort to improve demand forecasting.

"They're also investing in technology, including visibility and event management software," he continues. "This allows them to see the status of orders and inventories across the entire supply chain.It enables them to spot any problems before customer delivery and take corrective action or notify the customer of delayed delivery," he explains.

Interestingly, the impact of the recession wasn't all negative for supply chains and their operators. Neil Doyle, executive vice president for Infrastructure and Transportation Development at CenterPoint Properties, says the recession provided time for companies to redesign their supply chains to better reflect a particular customer's store network. He adds, "The downturn caused an in-depth look at each cost in the supply chain. As a result, supply chains emerged a lot smarter and leaner." Schultz comments, "Inventories fell during the recession as businesses tried to drive more costs out of the system and upgrade facilities to better functionality, more efficiency, and ultimately lower costs."

Quinn notes companies are thinking outside the box to make supply chains as efficient as possible. One new move in that direction is to combine complementary or even competitive products in the same supply chain to reduce transportation, labor, and warehouse costs.

Many firms outsource their supply chain operations to third-party logistics providers (3PLs). One such firm is Ryder System, Inc., whose vice president for Distribution Management is Bob Arndt. He says his firm employs five principles to achieve a leaner manufacturing concept for its clients:

"We engage people at all levels in the company to identify and eliminate waste. We're doing it with the cooperation of everyone in the organization pulling the rope in the right direction," Arndt says.

Third-party logistics providers help companies increase their flexibility and focus internal resources on core business operations. Arndt explains that supply chains are also being made shorter to improve customer service and cut costs.

This is being done by postponing final packaging of goods received from overseas. Product is sent unpackaged to the supplier, who stockpiles it and puts it in the appropriate customer packages when orders come in. Denser shipping is achieved by not having product in final packaging, helping to lower per item transportation cost. Also, suppliers can fill orders promptly versus sending an order to Asia, for example, and waiting for it to be delivered.

Re-thinking Network Models
Rising oil prices are of major concern to today's distribution operators. Prices have surged with the political violence in Libya disrupting that country's oil production. Prices are also rising in the wake of fears that the unrest may continue to spread to other oil-producing nations.

What's the likely outcome for distribution? Quinn remarks, "It'll make companies re-think getting product to the customer and re-think their current network models."

Feemster adds, "If oil prices rise to $125 to $150 a barrel and stay there, companies will be adding more and smaller warehouses located closer to customers to conserve fuel costs and still maintain the needed flow of goods. These smaller units would probably be in the 100,000- to 300,000-square-foot range versus the 800,000- to 1-million-square-foot range of the larger ones."

Schultz concurs that smaller warehouses closer to customers may be the order of the day if oil prices continue to rise. He points out that these centers will have to be smaller because of land scarcity in urban areas.

Quinn, however, disagrees that rising oil prices will lead to smaller distribution centers. He believes the opposite may occur, i.e., a trend toward fewer and larger distribution centers depending on a company's needs. Paul Hatcher, president of Oliver Hatcher Construction, a major warehouse builder, also doesn't see a trend toward smaller centers. "We're seeing firms looking for larger and larger facilities and more consolidation of warehouse operations as a means of reducing costs. Large regional warehouses are now in the 1.5 million-square-foot range."

And Arndt agrees with him. "We don't see a move out of large regional distribution centers. Moving is too expensive, and these centers are focusing on ways to achieve cheaper fuel costs."

According to Arndt, the emphasis today is on flexible warehousing. "Customers require change, so warehouses need to be in a position to react quickly without a lot of investment. Inventory control and small-lot processing are two of the primary tools used."

To help defray fuel costs, Feemster says companies are bidding out rates and farming strategic partnerships with truckload carriers. They foresee that demand for truckload business will exceed capacity. However, he notes that there's also a move to intermodal versus truck transportation, as well as the use of all-water transportation to Eastern and Gulf Coast ports instead of shipping to West Coast ports and transporting product by rail from there across country.

Under the heading of intermodal, Quinn cites the Heartland Corridor, a high-capacity rail line linking Norfolk, Va., to Columbus, Ohio. Total investment in the corridor by Norfolk Southern was more than $500 million, as the work included raising 22 overpasses to allow for double stacking of containers on railcars.

A Healthy Outlook for Warehouses
Sources agree on a positive outlook for warehouses. Arndt cites the trend to flexibility, meeting customer changes quickly. Feemster says warehouses are improving labor-management systems and upgrading their scoring, voice picking, and RFID (radio frequency identification) systems. Schultz comments, "Warehouse demand is up. There's a flight to quality with more efficient buildings, better clear height loading capacity and truck parking, more efficient lighting, and generally newer buildings."

Underscoring the healthy outlook, the U.S. industrial market finished 2010 with a notable surge, capping off three consecutive quarters of positive net absorption according to Colliers International. In its fourth quarter 2010 North America Industrial Highlights report, Colliers said solid demand for warehouse space in most regions, coupled with minimal new construction, has created the conditions for a sudden reversal in vacancy and almost certainly heralds the beginning of the next cycle. Demand for warehouse space is expected to increase as 2011 progresses, according to the report.

A giant positive for warehouse markets is the continued rise in import-export activity, which benefits port markets and also any distribution modes that are part of the supply chain. Another positive for warehouse markets is manufacturing, which continues to show surprising growth, Colliers noted.

Further affirmation of growth in the warehouse market comes in the first quarter 2011 PricewaterhouseCoopers Real Estate Investor Survey report. PwC says positive trends in the U.S. economy continue to impact the performance of the national warehouse market. The report cites a 7.1 percent increase in final sales of American products in fourth quarter of 2010. "This means that both consumers and businesses are again spending, which, if sustainable, will translate into more good news for the U.S. economy and the warehouse sector in 2011," the report concludes.

What are some industries leading the distribution parade? Arndt cites the food and electronics sectors. "Those bananas aren't going to sell if they hit the store overripe," he says. "The electronics industry must also respond quickly to changes in technology. They don't want to be sitting around with older product."

What is the single biggest concern facing distribution operators for the remainder of 2011 into 2012? It can be summed up in three words: rising fuel costs.