The Basics of Supply Chain Modeling

In a recent post, we outlined the justification for and initial steps involved in rethinking supply chain design. Briefly, in order for retailers to remain competitive with Amazon, it’s essential to identify ways to reduce shipping costs to be able meet the consumer’s new expectation of low cost two-day shipping services.

By taking a high-level look at your supply chain design and evaluating the costs and benefits of expanding your distribution network, you may discover that strategically locating additional distribution centers reduces two-day shipping costs significantly. The expansion of your network can position key inventory closer to customers and shipping destinations, thereby reducing indirect shipping paths and zones that are largely the cause of excessive two-day shipping fees. The most impactful outcome, however, may be the increased availability of two-day ground services to more regions which, of course, is much more cost-effective than two-day air. To determine the best supply chain design, you first have to do some supply chain modeling.

Supply Chain Modeling helps you optimize shipping costs and services.

The key to effective network expansion is identifying the optimal number, size and locations of the additional distribution centers. If you are currently able to deliver 35% of your packages via two-day ground, where would you position a second distribution center to enable the greatest possible increase in two-day ground deliveries? What would happen if you added two, three or many distribution centers to your network? Supply chain modeling can help you answer these questions.

Supply chain modeling allows you to experiment with different scenarios that weigh additional distribution centers against shipping costs. The idea is to find the combination that allows you to cost efficiently deliver two-day shipping to as many locations as possible at the lowest possible fixed price that the business can justify.

Step #1: Distribution Center Costs
The first step is to consider the key assets and cost factors for each additional distribution center. These are things like warehouse square footage, rack space, material handling equipment, computer systems, insurance, security and labor. Obviously, the greater the space and complexity, the greater the expense. Since network expansion spreads your previously consolidated inventory out to multiple locations, usually the additional warehouse locations can be quite a bit smaller than a central distribution center. By the same token, be sure to consider any changes in costs related to inbound receivables and handling that might occur if you expand the number and locations of your warehouses.

Step #2: Fixed Costs vs. Long-Term Committed Costs
There are two basic approaches to building out your distribution centers. You can outfit your own warehouse or hire a 3PL. If you set up your own, many of the costs you’ll incur become capital expenditures/fixed costs. If you hire a 3PL, then these become long-term committed costs.

Step #3: Distribution Costs & Modeling
Once you’ve estimated your core operating costs for an additional distribution center, you can begin to plot, model and compare shipping costs and volumes for each shipping zone from the new location. This is where you’ll quickly see the reduced costs for various levels of delivery services, especially two-day deliveries within single and nearby shipping zones. The more distribution centers you add, the more opportunities you create to ship via two-day ground at a substantially reduced rate.

Retailers who wish to remain competitive and meet new consumer shipping expectations should consider taking a step back to do some supply chain modeling. Some of the information above can take a little time to pull together and analyze, but what you discover in the end may be a revised supply chain design that’s well worth the effort.

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