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Distribution Strategies for Challenging Economic Times

The recession has left many companies with warehousing and distribution issues that can't be resolved with quick fixes. But solutions are there for those that make smart decisions and keep an eye to the future.

Nov 09
There are many reasons that warehousing real estate is busier than ever these days - and few of them have to do with construction. Although development of new distribution centers has come to a virtual standstill, numerous companies are in the market for new and different solutions to their warehousing challenges, including having more square footage or facilities than their current inventory levels require.

Area Development spoke with Catherine Thomsen, director of real estate for APL Logistics, to discuss some logistics real estate strategies that companies can employ to reduce the costs associated with their excess dry container space, as well as the quick fixes they shouldn't expect - and the compromises every company should be willing to make.
AD: You've been with APL Logistics for over 10 years and have seen a lot of trends. How would you characterize today's warehousing environment?

CT: The state of the economy has overshadowed everything. Every U.S. market has excess distribution space. Most warehousing landlords have quality space to fill. And if shippers are looking for domestic warehouses, it's usually an "instead of" situation rather than an "in addition to" scenario, because most companies' inventory levels are smaller than they were a year or two ago.

AD: Are shippers looking for this "instead of" space because their leases are coming up for renewal?

CT: In some cases, yes. However, landlords are also being approached by companies that still have several years left on their leases. These companies are looking to make creative arrangements such as consolidating their distribution into one of a landlord's mega-DCs in exchange for that landlord releasing them from some of the other smaller-facility contracts they've signed - or assuming the leases for the same.  
AD: Are landlords taking them up on these proposals?

CT: Most landlords I've talked with view these proposals as wishful thinking, not viable business propositions, especially if some of the facilities that companies are looking to get out of are located in more remote markets. Remotely located distribution space is a tougher sell in this day and age, and few landlords want to exchange more marketable square footage for less marketable facilities.

AD: Does this mean that landlords are unwilling to budge on warehouse leases?

CT: Not at all. Our company operates dozens of facilities on behalf of numerous clients, and we've successfully renegotiated many facility leases with landlords this past year to take some of the financial pressure off.

Everyone understands that we're living in tough economic times, and every business is feeling the pain. But there's a big difference between renegotiating a contract and trying to get out of one - or trying to make fair and equitable leasing terms a lot more lopsided in your favor just because you know the real estate market is hurting. Companies that are looking for those kinds of deals are likely to come up empty-handed.

AD: What kinds of items in a warehouse real estate contract are negotiable right now?

CT: Some landlords are willing to allow tenants several months of free rent on long-term contracts, and certain areas of facility maintenance are up for discussion during the lease negotiation phase.
But negotiation is the operative term. Companies must to be prepared to give landlords something in return for these concessions, even if it's just something incremental.

For example, one highly effective negotiating technique is being willing to renew a lease early. Another is being willing to extend the length of a lease.

AD: Since you mentioned maintenance and repairs, is this a significant factor in a company's warehousing cost?

CT: It depends on the maintenance issue. But it certainly can be.
For example, let's say some of the hardware used on the sprinklers in a warehouse's ESFR system is having problems and needs to be replaced. Not only could the cost of these new pieces of hardware be significant when you consider how many sprinklers an average warehouse has, so could the cost of any potential product damage if a sprinkler goes off and ruins inventory before repairs can take place.

Or consider the financial impact that replacing an HVAC system in a warehouse can have. If a company is only leasing a facility for a short while and it has to foot 100 percent of the bill for replacing the whole system rather than paying for its fair percentage of that system's life - the percentage of time it's actually using the system divided by the reasonable number of years a system should last - it could set that company back a lot more significantly than it should.

AD: Does this mean that companies should be scrutinizing their leased facilities' maintenance and repair costs more carefully during the lease negotiation phase?

CT: Absolutely. M&R clauses in warehouse leases vary, and companies should make sure that the clauses in theirs are tenant-friendly. Otherwise they may wind up with some maintenance costs that they could have negotiated away.

Companies don't just achieve cost savings by moving DCs, sending their logistics business out to bid, or renegotiating contracts. There's a lot of money to be saved merely by getting a better grasp of all of the costs involved with their facilities, keeping good records, and having good checks and balances in place to make sure that maintenance costs are in line with where they should be.

AD: A lot of logistics analysts and real estate consultants report that more companies are looking to work with third-party logistics providers (3PLs) as a result of the current logistics real estate situation. True or false?

CT: I think more companies are turning to 3PLs for a wide variety of reasons, including the opportunity for increased real estate flexibility. After all, one of the key benefits of working with 3PLs definitely is the ability to reduce your capital commitments by using a 3PL's facilities instead of your own.

But bear in mind that this benefit pertains more to companies that are using a 3PL's public warehousing facilities - where multiple tenants share the same building and can sign shorter contract terms - rather than one of a 3PL's contract warehousing facilities, where companies get the benefit of an entire facility and an entire facility's personnel dedicated to them.

AD: In other words, companies shouldn't expect a 3PL to provide them with the exclusive use of a mega-DC in a hot market for as long as they want it with no strings attached?

CT: Precisely. It's neither fair nor realistic to expect a 3PL or a landlord to assume all of the real estate risk in a relationship. If you want a 3PL to find, lease, and operate a great facility for you for three to five years, you should be prepared to enter into a contractual commitment for that facility for the same period of time.

AD: You mentioned that every market in the United States has a glut of distribution space right now. Does this pertain even to some of the more popular logistics locales such as southern California?

CT: Even in this tough economy, companies still will face a challenge if they want a dedicated facility right next to the ports in busy places like Los Angeles. But overall, there's high-quality space to be had in almost every U.S. market.

Some of it's available via landlords. Some of it is operated by 3PLs. And some of it is available via other shippers who are looking to sublease space they no longer need. It's a good time to be a tenant looking for space.

AD: So subleasing facilities' distribution centers is permissible?

CT: As long as shippers' contracts with their landlords permit subleasing, there's no reason why companies can't do it. It's a good way for some companies to get some very high-quality space, and it's an equally good way for companies who no longer need that space to cover some or all of their facility costs while they're still contractually obligated to facilities or space they no longer need.

AD: Let's assume that a company has explored a lot of these cost-trimming options you've suggested: It's renegotiated its leases, audited its maintenance expenses, and possibly sub-leased part of its facility. Are there any other cost-cutting options at its disposal?

CT: Without a doubt. Even if a company has binding real estate commitments to certain facilities for a long time to come, it should never assume that it's run out of cost-cutting options.

For example, companies might want to consider launching a lean warehousing program. We started one at our company a few years ago, and so far the participants have managed to find $10 million in savings, and most of these savings are tied to processes rather than real estate.

Another possibility is for companies to revisit how they're using freight management services, because the right routing solutions deployed by the right professionals can make a world of difference in terms of reducing freight bills.

Bear in mind that even though logistics locations are really important, transportation costs are still a significant part of companies' logistics expenses.

AD: One final question: Few people probably foresaw the real estate market and challenges we're in today. As you look down the road, what kinds of trends and opportunities do you think companies will face in the warehousing real estate market of tomorrow?

CT: I think you'll see a lot of warehousing growth in Asia, not just in terms of warehousing facilities being used to consolidate cargo headed for the Americas and Europe, but also in terms of facilities being used to distribute goods to the growing number of consumers in these markets.

If companies don't have an overseas warehousing strategy already, now would be a good time for them to begin developing one. I think you'll see an increased interest in green facilities, although the trend may be a bit farther down the road than some people might like because developers started capping production of new facilities right as the green movement really hit its stride, and it may take some time for them to make green construction standard operating practice.

And of course, the expansion of the Panama Canal will have a huge impact on port diversification, which will in turn have an impact on where companies want to situate their U.S. distribution centers.

Finally I wouldn't be surprised to see the pendulum swing. It may be a tenants' market in terms of looking for DC space right now. But with supplies of new warehouses having been capped so long, I don't think it's far-fetched to foresee a time when companies' demand for newer, greener, more efficient warehouses could outstrip supply in various markets.

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