Evolution of the Global Supply Chain | Cost-Cutting-Initiatives

If you're thinking of renegotiating your lease to reduce costs, now is absolutely the time to act. It's just like refinancing your home to lower the interest rate; you have to pick the right time to do it, and this is one of those right times in commercial industrial real estate when you can exploit your rent-paying leverage. Landlords in today's economy are motivated to get creative to keep existing tenants and get new ones. But if you are breaking your lease just to save a few bucks, you are not really taking advantage of the overall market situation. The key is not just to lower your rental cost, but also to look at your network holistically, considering all of the four trends in the logistics landscape outlined below to more strategically adapt your network.

Supply Chain Trends
The ongoing evolution of the global supply chain continues to mold new patterns and trends in industrial real estate across North America. The following trends are impacting how companies design their supply chain networks:

1. One trend is the shifting of ocean container import traffic coming from Asia to U.S. Gulf and East Coast ports in lieu of the West Coast ports, and even the potential of near-sourcing down the road.
Companies are moving the inbound port of entry to the Gulf and East Coast ports to reduce transportation costs and drive down their carbon footprint for goods destined for the Southwest, Southeast, and Northeast. Since 2006, the Gulf and East Coast ports' share of the overall container volume has moved from 39.7 percent to 43.9 percent (YTD May 2009) of the total U.S. container trade. That is more than a 10 percent change in just three years. This shift is expected to advance rapidly when the Panama Canal expansion is completed in 2014/2015.

2. Volatility of energy prices and its related effect on transportation costs impact domestic distribution networks.
The cost of diesel has moved from a low of $2.44 a gallon in 2006 up to $4.76 a gallon in 2008. In 2009, it fell to $2.02 and then shot back up to $2.62 a gallon by mid-year. Oil and diesel prices are driven by the global demand. That demand is driven by the economic situation, and the experts predict that when the global economy returns to "normal," oil and diesel will rise beyond where they are today. Company executives need to look at future cost of transportation plus fuel surcharges when looking at their network, not at past costs.

3. There has been an increase in the importance of sustainability as it relates to our transportation methods and building LEED strategies. Do you shift transportation to rail and/or rail intermodal? What can you do to make your existing facilities more sustainable, if not LEED-certified?

As most best-in-class performance companies adopt a sustainability strategy, there is a need to look at your supply chain, as it is a large contributor to the carbon footprint of an organization (including manufacturing locations as part of the supply chain). We know that water transport is more energy-efficient than rail, and that rail is better than truck. So you need to look at ways to utilize the lower cost/carbon footprint modes of transport for longer legs as you redesign your supply chains.

In addition, the Environmental Protection Agency has a partnership with carriers called SmartWaySM (https://www.epa.gov/smartway). All these carriers have committed to specific goals to improve the efficiencies of their fleets/equipment to reduce their carbon footprint. Again, best-in-class performance companies are selecting only transportation providers from this group.

Inside the four walls of company facilities, there are many things that can be done to increase sustainability with no or low upfront cost. You can design sustainable buildings by utilizing LEED construction practices when building new facilities, even if there are no plans to certify the structure. For more information on LEED certification standards, go to https://www.usgbc.org.

4. Today's focus on supply chain cost-reduction initiatives is allowing users to take advantage of market vacancy and the current recessionary economy situations to generate network cost reductions.

Some of these cost-reduction initiatives have been highlighted. It is important to note that whatever initiatives you adopt, they need to be coordinated with overall company strategies. Often companies realize that they need professional help in some areas of this process, e.g., strategic planning, commercial brokerage, network modeling, incentive negotiation, lease administration, project management, property management, and/or corporate finance. Often full-service commercial real estate firms may be a better choice than a supply-chain consultant because they have all these capabilities and more in-house.

Overall Strategy
So how do you attack the situation? First and foremost, you need to step back and look at the overall supply-chain strategy and how it meets the overall goals and objectives of the company. Some key questions to consider are:

• How is the increasing cost of fuel impacting your inbound and outbound transportation costs?

• Should you take advantage of "all water" routes to the East Coast on inbound container freight as a means to reduce your carbon footprint as well as to lower the cost to deliver to your East Coast distribution centers?

• Should these centers be at the port or close to inland intermodal hubs?

• Do you plan to "near source" your production or continue to "offshore" source?

• Is your outbound transportation expense being driven up rapidly by escalating costs for less-than-truckload deliveries?

• Can you utilize more domestic intermodal for outbound shipments to customers in order to lower costs and reduce carbon footprint and, therefore, need to be closer to these facilities to minimize drayage cost?

• Should you consider a more "market-centric" network to minimize your overall supply chain costs?

• When do your leases expire?

• Do you own facilities that have become "functionally obsolete" in today's environment?

• How do you stack up against your competition on your go-to-market execution?
You need to answer all these questions with a comprehensive analysis of the company's overall cost structure and go-to-market strategy before you should even consider updating a single lease.

A Five-Step Process
The five-step process outlined in Figure 1 will allow your company to take full advantage of all the planning, restructuring, optimizing, and/or right-sizing it needs to execute in order to maximize the impact of revising the supply chain to meet the future expectations of the firm, the economy, and market globalization.
First, let's start with the compatibility of strategies, goals, and objectives within the organization. The ideal is that all functions are aligned using a sequence of balanced scorecards that all point to company goals as set by the senior management and board of directors.

We all know that, in reality, many companies have silos that have little or no linkage between their goals and those of the company or each other because these functions don't sell, produce, or operate anything - they are overhead departments. Most corporate goals revolve around sales growth and profits within certain customer service criteria. It is the "within certain customer service criteria" that causes the divergent and conflicting departmental goals.

When it comes time to do a performance review, how do you think the real estate VP would fare if he just closed a deal on a ideally designed and located 500,000-square-foot facility where the rent was $7.50 per square foot when he passed up a similar size building with a rent rate of $5.50 per square foot that was not the ideal configuration or location? On the surface, it would seem he just cost the company $1 million annually. These numbers are right, but they do not tell the whole story; the real estate person may have just made an exceptional deal at $7.50 per square foot, in partnership with his operations team, since the overall supply chain cost - including rent, transportation, and labor - of the "expensive" building was $1 million less than that of the "cheap" one.

For "the rest of the story," we have to look at supply chain costs in various functional groups. According to a recent study by Establish, Inc./Herbert W. Davis and Company, over 50 percent of the total cost of logistics is transportation. Labor and customer service costs total an additional 17.3 percent. Rent only accounts for 4.3 percent of total costs. (See Figure 2.)

Some companies believe they can largely disregard transportation costs and base their location decisions on tempting incentives from local government agencies. As you can see from Figure 2, this can lead to a suboptimal solution based on overall costs.

Rather than leave the site selection decision-making process to any single department, best-in-class performance companies are putting together a cross-functional team combining logistics and real estate, along with finance, operations, and sales. This builds a companywide consensus on strategy that takes all the goals and objectives of all groups into consideration.

The first step in the process is to research costs and set overall project objectives and timelines. The big drivers in choosing any location for warehouse and distribution centers should be transportation and labor. When calculating transportation costs, most companies have traditionally focused on outbound costs because they are easier to calculate than their inbound costs. The company knows where its customers are, and which routes and transportation modes must be used to supply them. Inbound costs are more difficult to calculate because you have less information, and many times this cost is paid by the supplier and buried in the price of the item.
But best-in-class companies now are taking inbound logistics costs into consideration when they select sites for distribution centers and warehouses. As supply chains spread around the globe, they become increasingly complex and difficult to manage. For many global companies, inbound transportation routes are changing, along with the identity of suppliers, who come and go according to their cost structure and quality performance.

Once the strategy is set you begin step 2, modeling the total landed cost of the supply chain to find the "optimum" networks that are within a narrow band of the lowest cost given your customer service guidelines. There may be multiple iterations in this step since your company may have to research new inbound gateways and outbound transportation companies and modes.

Then you move into step 3, where you narrow down the overall list of network options for further analysis. In this step, you rate site/city specific attributes of each node in each of the network options. You also look at things like quality of life, unemployment rates, labor rates, community size, labor force education levels, right-to-work situation, foreign-trade zones, existing lease terms, owned facilities, and local/state business climate. The ensuing "priority matrix" clearly identifies the total score of each network and node within it. Now you can narrow the number of options to run through steps 4 and 5.

In step 4, field visits are conducted to make contact with economic development groups, commercial brokerage professionals, local labor providers, and potential real estate developers. You will tour the market to determine how well the existing and planned facilities meet the company's needs, and talk to the economic development teams to determine what incentives at the city, county, state, and federal level would be in play for this node in the revised network. Now you have the basis to pick the best two networks to move to step 5.

You get serious in step 5 with final network locations regarding incentives, lease rates, length of lease, free rent, facility buildout requirements, etc. Once you have analyzed all this data, you are ready to make a recommendation to your company's senior management. Once approval is granted, maybe with slight modifications, you begin the process of implementation and execution.

By utilizing this process, you have built a new network to support your company's business that is based on shared goal achievement, future cost expectations, and solid analysis. You have taken most of the emotional element out of the process. Most of all, you have documented the steps and results so you can repeat them in the future should the environment change, requiring a "re-do."