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VOLUME 24 • NUMBER 7 • jUNE 2009
2009
VOLUME 24 • NUMBER 7 • JUNE 2009
Understanding Warehouse Costs and RisksBy Thomas W. Speh, Ph.D.
Editor’s Note: Presented here is a revision of an article writ-ten nearly two decades ago by professor Tom Speh, of MiamiUniversity, Oxford, Ohio. When written, the purpose of thiswork was to provide a guideline for public warehouse opera-tors and their customers. Both buyer and seller were accus-tomed to a transactional pricing and costing system thatcombined a monthly price per unit for storage with the costs ofmaterials handling and administrative services. The vendorneeded to make certain that this pricing would yield a profit,and the buyer wanted to be sure that no money was left on thetable. In revising this work, we recognize the need to create amechanism that is useful for wholesale distributors, as well aslogistics service providers who are not using unit pricing.Both buyer and vendor need to understand the process, in or-der to compare price to actual value of the services rendered.KBA
Warehousing is nothing more than the management ofspace and time. The space management portion, storage,has a cost per month, because there is a monthly cost forwarehouse space. The time management component in-cludes labor involved in handling materials as they movein and out of the warehouse. If you are buying or sellingwarehouse services, or simply providing warehousingservices for your own organization, the models that arepresented in this article will enable you to isolate and ana-lyze the costs of warehousing.
All companies with warehouses incur the same ele-ments of cost, but they compile them differently. The goalof this article is to convey a costing system that can beused to compare costs of one warehouse with another, orone company to others.
Some warehousing costs tend to be ignored ormisallocated, because the analyst does not recognizewhere they belong. In any costing system, allocation ofoverhead costs is a matter of judgment, and no specificformula will be correct for every user. The cost modelsshown here have been designed to ensure that no item isoverlooked. We assume that each user will customize themodels, and make individual judgments regarding alloca-tion of administrative costs.
Four Categories Of Warehouse Costs1. Handling. All expenses associated with moving
product in or out of the warehouse should be included in
the handling cost center. The largest component is the la-bor used to handle the product that moves through the dis-tribution center. It includes receiving, put-away, order se-lection, and loading. It also may include labor tore-warehouse, repackage, or refurbish damaged product.
Handling also includes all costs associated with theequipment used to handle product in the warehouse, suchas the depreciation of equipment cost, and the cost of fuel,or electricity to power the equipment.
Other handling expenses are the detention of truck orrail cars, operating supplies, and trash disposal. In effect,handling includes all those costs that are associated with“goods in motion.”
2. Storage. Storage expenses are costs associated with“goods at rest.” These costs would be incurred whether ornot any product ever moved. Because storage expensesare related to the cost of occupying a facility, and thesecosts are normally accumulated each month, storage is ex-pressed as a monthly cost. If an entire building is dedi-cated to an operation, storage expenses are the total occu-pancy cost for that facility.
3. Operations administration. These expenses are in-curred to support the operation of the distribution center.Closing the facility would eliminate these costs. Includedare costs for line supervision, clerical effort, informationtechnology, supplies, insurance, and taxes.
4. General administrative expenses. Expenses not in-curred for a specific distribution center are included inthis category. General management, nonoperating staff,and general office expenses are examples. Allocation ofsuch expenses to each warehouse is a judgment call.Productivity Improvement
Most warehousing costs, particularly storage and han-dling, can be influenced by improvements in productivity.Improved methods and equipment may enable the opera-tor to increase the number of units moved without increas-ing labor, resulting in a higher number of units handled perhour. Changes in inventory, storage layout or equipmentmay enable the operator to expand the number of unitsstored in the same number of cubic feet of storage space.The Risk Factor
Cost per unit is escalated when a distribution center isnot fully utilized. Fixed costs always will be influenced bythe rate of utilization. Variable costs, such as labor, never
What Only the CEO Can DoBy A.G. Lafley, Harvard Business Review, May 09,pg. 54
Most people consider the chief executive to be acoach and/or a problem solver. The author, of this ar-ticle, CEO of Procter & Gamble, views the job differ-ently. Only the CEO can link the external world withthe internal organization, and that must be done, be-cause without that link the company cannot succeed.Lafley recognizes these four tasks of the CEO:
Define the “meaningful outside.” How do weconnect with the ultimate consumer?Decide what business you are in. At the sametime, determine what businesses you shouldnot be in.Balance present and future. Consider bothshort-term and long-term goals and results.Shape values and standards. Are they relevantfor both today and tomorrow?
WMS: A Blueprint For SuccessBy Chris Werling, Parcel, March 2009, pg. 30.
Written by an independent consultant, this articleserves as a useful primer for implementation of ware-house management systems.
The first step is testing, ensuring that every aspectof the system functions as expected. Training shouldstart early, and include those on the warehouse flooras well as the office staff who work with the system.The timing of conversion, the process of moving datato the new system, may be critical. Validation is a sec-ond test to confirm that everything is on track. Themost common mistakes in implementation resultfrom poor planning, improper training, and/or inac-curate item analysis.
Cost-Saving Strategies for ContractsBy J. S. Millstein and Tim Roughton, CSCMP’s Sup-ply-Chain Quarterly, Quarter 1/09, pg. 34.
The authors of this article are lawyers in the NewYork and London offices of a corporate law firm.They addressed four areas that offer opportunities toimprove outsourcing contracts with new ways to cutcosts. The four areas are flexibility, enforcement ofcontractual rights, renegotiation and leverage. Re-garding flexibility, they stress the importance of rec-ognizing the price of superior service. Don’t ask foror agree to service requirements that truly are notneeded. In these difficult times, a dispute resolutionprovision is an important part of every outsourcingagreement. Changing economic conditions may sig-nal the need to renegotiate terms that were acceptableprior to the current recession.
Finding New Value In Truck Leasing,By Gene Scoggins, Inbound Logistics, April 2009,pg. 26.
The author, president of NationaLease, a majorprovider of leased motor trucks, focused on transpor-tation equipment in this article; yet the same argu-ments apply to lift trucks, and other capital equipmentused in warehouses. Some advantages of equipmentleasing include the following:
P Conserve capital to grow the business. Yourdollars might earn more with many other in-vestments.
P Manage credit. In today’s banking climate, fi-nancing of equipment can be challenging.
P Avoid depreciation losses. Leased equipmentis not depreciated.
P Control maintenance costs.
Compliance EducationBy Chris Gillis, American Shipper, March 2009, pg. 9.
Managers who are ignorant of federal regulationsgoverning import and export activities run the risk ofincurring severe penalties and unwanted publicity.The World Academy, based in New Jersey, offersthree-day compliance seminars for shippers and lo-gistics service providers. More information is avail-able at www.theworldacademy.com.
Motivating Your Staff During A Down EconomyBy John Brown, Material Handling Management,May 2009, pg. 44.
When a California trucking company faced theneed to reduce salary expenditures by 20%, manage-ment elected to adopt a four-day work week ratherthan resort to a layoff. At the same time, the companylaunched a training program conducted by a profes-sional business coach. The six-week program was en-titled, “Battling Burnout and Regaining Control.”Many of the sessions were forum discussions that per-mitted workers to express their fears and anxieties.The CEO stated, “I was pleasantly surprised at howmuch they helped me cope with the stress of leading acompany during this economic storm.”
Logistics Bright SpotsAmerican Shipper, May 2009, pg. 16.
An increasing number of logistics service provid-ers are using solar energy to power their facilities.Warehouse roofs are ideal for solar panel installationsbecause they offer large expanses of access to sun-light. All of the examples provided in the article arefrom facilities on the Pacific coast.
are quite as flexible as they seem. Management may be re-luctant to eliminate experienced workers, particularlywhen they will be needed for a coming busy season. Thesame is true for forklift trucks and other materials han-dling equipment. Therefore, the primary risk in control-ling costs is the rate of utilization.
Errors represent another unknown risk. People makemistakes, which may result in product damage and errors,or shipping errors.
Just as the insurance underwriter factors in the risk ofloss, the warehouse operator must make a realistic esti-mate of risk costs. Risk may be expressed as a percentageof total warehousing costs. It should be based on past ex-perience. Methods to reduce risk should be explored.
The simplest way to calculate the risk factor is to in-clude it in the size of the markup. Many time and materialagreements have a low percentage of profit, but the unitpricing agreement must factor in a higher profit percent-age that reflects the substantial risk of changing volume.
As you contemplate the risk factor, consider the posi-tion of the buyer. With a time and material agreement, thebuyer agrees to pay for all space and labor that is used,which often includes the rent for a building that is dedi-cated for the buyer’s use. In contrast, the buyer of a unitprice agreement pays only for services that actually areused. Expansion and construction can be challenging, aswell as costly.
Agood analogy is the difference between a hotel and anapartment. When you stay in a hotel, the price per squarefoot of space occupied is higher than the cost of leasing anapartment. You pay the premium because you want theflexibility of occupying the space only on the days youneed it. While the apartment may be cheaper, you pay forit whether or not it is in use.Developing a Handling Price
A building block approach, using the categories ofwarehousing costs included in this article, can be used todevelop an hourly selling price. First, all of the costs listedin section I, Handling, are totaled. Next, a portion of thecosts in section III, Operating Administrative Expense,and in section IV, General Administrative Expense areadded to direct handling expense, in order to develop aburdened handling expense. An additional percentage ofprofit is added to develop a handling sales price. This fig-ure is divided by the hours billed, to convert the figuresinto a handling fee per man-hour. While you may not in-voice your customers by the hour, the hourly fees can beused to check the validity of current pricing.Creating A Storage Price
A similar building block approach is used, but the re-sult is expressed in square feet, rather than hours. Sincestorage costs increase with time, this storage fee is ex-pressed on a per month basis.
The first step is to total all costs listed in section II,Storage. Following the handling example described inthis article, a portion of operating and general administra-tive expenses must be added, in order to develop a bur-dened storage expense. Then, a desired profit margin per-centage is added to create a price per square foot permonth. That price determines the storage rate per unit.
The Importance Of Inventory TurnsBecause storage costs are calculated on a monthly ba-
sis, the total cost of storing an item depends on how long itwill be in the warehouse. In the past, each unit receivedfor storage had an anniversary date with renewal storagecharges added each month afterward. Later billing sys-tems were designed to simplify the clerical task by charg-ing a half month for items received after the 15th of themonth, and a full month for everything in storage on thefirst day of the succeeding month. Regardless of the sys-tem used, an inventory that turns 24 times per year shouldcost less to store than one that turns six times per year. Forthat reason, the inventory turn rate is a critical data pointin creating storage prices.
The “Make Or Buy” FactorNearly all services available from a logistics service
provider can be replicated by an internally managed pro-ject. The buyer who knows the amount of space needed,and has estimated the number of people required to staffthe operation, should be able to simulate the“do-it-yourself” cost of providing comparable logisticsservices. This cost is then compared with the prices of-fered by a logistics service provider. In this situation, therisk factor is critical. The do-it-yourself option is full ofrisk, unlike a unit price agreement that provides maxi-mum flexibility because the risk is absorbed by the logis-tics service contractor.
Living With Hurdle RatesWhen your company makes an investment in logistics
facilities, financial managers want to know about the re-turn on investment. Hurdle rate reflects the minimum per-centage of investment return that is acceptable for yourcompany. If you choose the “do-it-yourself” option, yourreturn on investment will be based on the dollars saved,rather than the cost of contracting the service to anotherparty. Yet, you must recognize the substantial risk of do-ing it yourself, then compare it to the employment of anindependent service provider.
Simulating A Logistics Service ProviderSome private warehouse operators treat their opera-
tions as if they were public warehouses. Transfer costs forinternal storage and handling prices are determined, andthe warehiouse manager is held accountable for profitableoperation at the established rates.
Thomas W. Speh is Associate Direc-tor of MBA Programs at Miami Uni-versity. He also holds a part-timeposition with CSCMP, as Directorof Strategic Initiatives. Dr. Speh re-tired from full-time teaching at Mi-ami's Farmer School of Business in2008, where he taught courses inLogistics and Supply Chain Man-agement for 35 years. He haswoorked on consulting projects in avariety of supply chain areas withmany different firms.
We have tried to maintain a neutral position on contro-versial issues, and avoided any approach that appears tofavor a single political party. That said, your editor hasconcluded that the Employment Free Choice Act, alsoknown as EFCA, or the card check bill, is the most danger-ous legislation proposed in the United States for morethan half of a century. It should not be a partisan issue.
Certain facts are undeniable. Labor unions were an im-portant factor in industrial reformation during the 19thand early 20th centuries; yet, the percentage of the union-ized workforce has declined each year during the past halfcentury. The logistics service industry, like many others,has been transformed from a unionized business to onethat is nearly union free. Labor leaders, facing the pros-pect of extinction, have contributed significant donationsto politicians who agree to sponsor legislation allowingthem to expand. EFCA, for the labor lobby, is payback forpolitical contributions and support.
The EFCA is dangerous for these reasons: First, it willdeny the secret ballot to workers who face a choice ofwhether or not to recognize a union. Second, if a unionclaims recognition and begins to negotiate, a federal arbi-trator will dictate a settlement if no agreement is reachedwithin 90 days.
Unions essentially are a franchise business, and the un-ion organizer is compensated for expanding the group. Ifthat individual is unscrupulous, a variety of illegal tech-niques may be employed to induce prospects to sign a un-ion recognition card. This could, and has, included ha-rassment and personal threats.
There is no law that can force a corporation to remain inbusiness. Thousands of business owners would liquidatetheir companies rather than suffer with a hostile work en-vironment; therefore, passage of EFCA has the potentialto convert the current recession into a second Great De-pression that is worse than 1929.
Two legal scholars, writing for the Wall Street Journal,have expressed the opinion that EFCA is unconstitutionalbecause it denies citizens the right of the secret ballot. Un-fortunately, the test of constitutionality cannot take placeuntil, or unless, the legislation is passed.
The majority of people in this country are union freeand want to stay that way. Our Congress is supposed to re-flect the will of the people. If you believe that EFCA is athreat to our economy, contact your Senator and Repre-sentative, and ask them to reject this legislation.
The Influence Of Future ShockIn 1970, Alvin Toffler broke new ground with his
book, Future Shock. Published in 15 nations, this book in-fluenced the world public, with its message that futureshock is a disease suffered by people who are over-whelmed by change. The real problem was not change,but acceleration of the pace of change.
The recorded history of mankind equals 800 lifetimes,at 62 years each. Of these 800, 650 were spent in caves.Writing has been used only for the last 70, and printingduring the last seven. Most of the products we use todaywere developed during the last two. These events havechanged our world since Toffler’s book was released:
The United States suffered the worst attack on itssoil in our history.Radical terrorists have engaged in a global waragainst the United States and other Western na-tions.The Soviet Union collapsed.For the first time, the United States lost a war.One United States President was forced to resign,and another was impeached.Transportation was deregulated in the UnitedStates.The costs of communicating and computing havefallen drastically.We have suffered the worst economic downturnsince the Great Depression.
During 1970, Federal Express and the expectation ofovernight delivery service was no more than a dream inthe mind of founder Fred Smith. While “just in time” wasutilized in Japan, it was unknown in the United States.Barcode technology had not yet entered the warehouse.ESFR sprinkler systems, which made older systems obso-lete, were not yet introduced. Computers were bulky andexpensive machines, and the warehouse management sys-tems we use today did not exist.
The web-based technology, which is used widely inwarehousing and other business activity, was unknown in1970. The concept of the lean organization had not yetbeen developed. While processing of returns always was anecessary evil, the concept of reverse logistics had not yetbeen introduced.
The Growth OfA Flexible Workforce
As the economy recovers, warehouse operators mayelect to use staffing service employees rather thanfull-time workers. Others will use permanent part timers,such as college students, who are unwilling to take a fulltime job.
If there is a downturn in volume, the flexible workersare the first to be cut. This provides increased stability tofull-time workers, which can be a positive morale factor.
EFCA --A Threat To
Private Enterprise
A FORM FOR WAREHOUSE COST CALCULATION
I. HANDLING
A. Labor1. Direct payments:
a. Wages . . . . . . . . . . . . . . . . . . . . $________b. Overtime . . . . . . . . . . . . . . . . . . $________
2. Fringe benefitsa. Health insurance . . . . . . . . . . . . $________b. Pension . . . . . . . . . . . . . . . . . . . $________c. Life insurance . . . . . . . . . . . . . . $________d. Uniforms . . . . . . . . . . . . . . . . . . $________e. Other . . . . . . . . . . . . . . . . . . . . . $________
3. Compensated time offa. Vacation . . . . . . . . . . . . . . . . . . $________b. Holidays . . . . . . . . . . . . . . . . . . $________c. Sick leave . . . . . . . . . . . . . . . . . $________d. Jury duty . . . . . . . . . . . . . . . . . . $________e. Funeral leave . . . . . . . . . . . . . . . $________f. Other . . . . . . . . . . . . . . . . . . . . . $________
4. Taxesa. FICA . . . . . . . . . . . . . . . . . . . . . $________b. Workers compensation . . . . . . . $________c. Unemployment compensation . . $________d. Other . . . . . . . . . . . . . . . . . . . . . $________
5. Temporary labor 6. Development costs
a. Training . . . . . . . . . . . . . . . . . . . $________b. Education allowances . . . . . . . . $________c. Other . . . . . . . . . . . . . . . . . . . . . $________
B. Handling equipment1. Lift trucks and attachments
a. Rental . . . . . . . . . . . . . . . . . . . . $________b. Depreciation and interest . . . . . . $________c. Maintenance . . . . . . . . . . . . . . . $________d. Motor fuel or electricity . . . . . . $________
2. Conveyorsa. Depreciation and interest . . . . . . $________b. Maintenance . . . . . . . . . . . . . . . $________c. Electric power . . . . . . . . . . . . . . $________
3. Palletsa. Purchase or replacement costs . . $________b. Repair . . . . . . . . . . . . . . . . . . . . $________
C. Other handling expenses1. Detention/demurrage2. Recouping damaged product3. Trash and/or snow removal4. Maintenance of loading docks and related
equipment
II. STORAGE
A. Facility1. Rent, or depreciation and interest . . . $________2. Taxes . . . . . . . . . . . . . . . . . . . . . . . . $________
II. STORAGE (continued)
3. Insurance . . . . . . . . . . . . . . . . . . . . . $________4. Building maintenance . . . . . . . . . . . . $________5. Other . . . . . . . . . . . . . . . . . . . . . . . . . $________
B. Grounds1. Lawn and landscaping maintenance . $________2. Parking lot maintenance . . . . . . . . . . $________
C. Storage equipment (racks and/or shelving)1. Depreciation and interest . . . . . . . . . $________2. Maintenance . . . . . . . . . . . . . . . . . . . $________
D. Utilities1. Heat and/or temperature control . . . . $________2. Lighting . . . . . . . . . . . . . . . . . . . . . . $________
E. Security1. Sprinkler and other
fire protection systems . . . . . . . . . . $________2. Electronic burglar alarms . . . . . . . . . $________3. Guard service . . . . . . . . . . . . . . . . . . $________
F. Pest control
G. Other facility expense
III. OPERATING ADMINISTRATIVE EXPENSE
A. Supervisory salaries . . . . . . . . . . . . $________
B. Clerical salaries . . . . . . . . . . . . . . . $________
C. Labor purchased from staffing services . . . . . . . . . . . . . . $________
D. Office and data processing equipment1. Depreciation and interest . . . . . . . . . $________2. Software . . . . . . . . . . . . . . . . . . . . . . $________3. Maintenance . . . . . . . . . . . . . . . . . . . $________4. Training . . . . . . . . . . . . . . . . . . . . . . $________E. Office maintenance . . . . . . . . . . . . . . $________F. Communications costs . . . . . . . . . . . $________G. Legal and professional . . . . . . . . . . . $________H. Taxes and licenses . . . . . . . . . . . . . . $________I. Travel . . . . . . . . . . . . . . . . . . . . . . . . $________J. Insurance and claims . . . . . . . . . . . . $________K. Losses due to damage, shortages
and errors . . . . . . . . . . . . . . . . . . . $________
IV. GENERAL ADMINISTRATIVE EXPENSEA. Executive salaries . . . . . . . . . . . . . . . $________B. Executive office expenses . . . . . . . . $________C. Selling and advertising expenses . . . $________
When Does MechanizationMake Sense?
The short answer is that the investment is sound whenpayback is reasonably sure, and short. Equipment ven-dors are taught to demonstrate payback, and any buyerwho does not ask the salesman about return on investmentis asking for trouble.
Mechanization always has risks, the biggest of whichis that equipment won’t function as promised. Anotherrisk is a lack of flexibility, and warehouse mechanizationalways has had an inverse relationship to flexibility. Tosome extent, this has changed with robotic equipment,some of which is capable of reprogramming, or even mov-ing to another building.
Payback also is related to volume, so there is a risk thatunexpected erosion of volume will increase payback timefar longer than originally estimated. Because logisticsservice providers seldom are able to control volume,mechanization is especially risky for the logistics serviceprovider.
Mechanization should save either space or time, and inrare instances, it may save both; therefore, the greatest op-portunities are in the most labor intensive warehousejobs. These include building or stripping pallets, pickingorders, or handling of less-than-case quantities. Ex-tremely long travel within a warehouse also is a candidatefor mechanization.
When land is extraordinarily expensive, mechaniza-tion, such as stacker cranes, will enable an unusualamount of material to be stored in a modest number ofsquare feet. It can be used to eliminate unpleasant,hard-to-fill jobs, such as labor within a freezer ware-house, or to improve accuracy, such as using bar codescanning or voice recognition to reduce receiving and/orshipping errors.
In the last analysis, measure the risk, and balance itagainst the projected reward. Where possible, share therisk with the vendor.
Relocating YourDistribution Center
Here are four of the most frequent reasons why ware-houses must be moved:
The facility is too small and cannot be expanded.The customer base is changed, and the present lo-cation does not adequately serve the new market.The supplier base has changed, and the current lo-cation is not ideal.Because of mergers and acquisitions, your com-pany now has too many warehouses.
Several factors must be evaluated when consideringthe location of a warehouse. Cost and availability of trans-portation is the most important variable, because trans-portation is the largest logistics cost for most companies.
Measurement of risk, including fire protection, and therisk of flood, windstorm, and earthquake is nearly asimportant. Is there a contingency plan if a natural disasterwiped out the warehouse?
Cost and availability of labor is of varying importance,since some warehouse operations are more la-bor-in-tensive than others.
Finally, tax incentives are a good indication of howbadly a community wants to attract new warehouse opera-tions. In some cases, they can provide significant savings.
Company StatementsIn addition to financial statements, many companies
publish written statements to inform employees, custom-ers, and the public what they stand for. Company mission,values, vision and strategy usually are included in thestatement.
The mission statement explains why the company ex-ists. A values statement describes your beliefs and behav-iors. Vision tells where you are going and what you wantto be. Strategy describes your competitive game plan.
Few warehousing companies publish all four state-ments. As well, many companies publish statements thatare so bland and generic that they are meaningless.
Form Follows FunctionHave you ever asked why your warehouse exists? Why
was it established? Why is it located where it is?It is not uncommon to find a warehouse operation that
has strayed far from its original function. Perhaps a mix-ing center also is being used as a storehouse for slow mov-ers. Or, a factory storehouse currently is used to handle re-turned merchandise. If the form has strayed from the orig-inal function, was it because of a careless error, or a delib-erate change of policy? In too many cases, the change isaccidental. In nearly all instances, the change of form de-grades the original function of the warehouse. For exam-ple, if it is a mixing center, it should never be too full, norshould it contain the slowest moving items.
Contain Hidden CostsWith WarehouseManagement Systems
How often is an item lost in your warehouse, only toturn up later during a physical inventory? How much timeis spent searching for lost items? How much time is spentchecking the work of order pickers or receivers, eventhough the function can be performed electronically?How many shipments are returned because the wrongproduct was sent? What is the total cost of an incorrectlyshipped order? How much time is spent in cycle counting,or conducting full physical inventories?
All of these functions can be enhanced and improvedwith the application of a warehouse management system.
are quite as flexible as they seem. Management may be re-luctant to eliminate experienced workers, particularlywhen they will be needed for a coming busy season. Thesame is true for forklift trucks and other materials han-dling equipment. Therefore, the primary risk in control-ling costs is the rate of utilization.
Errors represent another unknown risk. People makemistakes, which may result in product damage and errors,or shipping errors.
Just as the insurance underwriter factors in the risk ofloss, the warehouse operator must make a realistic esti-mate of risk costs. Risk may be expressed as a percentageof total warehousing costs. It should be based on past ex-perience. Methods to reduce risk should be explored.
The simplest way to calculate the risk factor is to in-clude it in the size of the markup. Many time and materialagreements have a low percentage of profit, but the unitpricing agreement must factor in a higher profit percent-age that reflects the substantial risk of changing volume.
As you contemplate the risk factor, consider the posi-tion of the buyer. With a time and material agreement, thebuyer agrees to pay for all space and labor that is used,which often includes the rent for a building that is dedi-cated for the buyer’s use. In contrast, the buyer of a unitprice agreement pays only for services that actually areused. Expansion and construction can be challenging, aswell as costly.
Agood analogy is the difference between a hotel and anapartment. When you stay in a hotel, the price per squarefoot of space occupied is higher than the cost of leasing anapartment. You pay the premium because you want theflexibility of occupying the space only on the days youneed it. While the apartment may be cheaper, you pay forit whether or not it is in use.Developing a Handling Price
A building block approach, using the categories ofwarehousing costs included in this article, can be used todevelop an hourly selling price. First, all of the costs listedin section I, Handling, are totaled. Next, a portion of thecosts in section III, Operating Administrative Expense,and in section IV, General Administrative Expense areadded to direct handling expense, in order to develop aburdened handling expense. An additional percentage ofprofit is added to develop a handling sales price. This fig-ure is divided by the hours billed, to convert the figuresinto a handling fee per man-hour. While you may not in-voice your customers by the hour, the hourly fees can beused to check the validity of current pricing.Creating A Storage Price
A similar building block approach is used, but the re-sult is expressed in square feet, rather than hours. Sincestorage costs increase with time, this storage fee is ex-pressed on a per month basis.
The first step is to total all costs listed in section II,Storage. Following the handling example described inthis article, a portion of operating and general administra-tive expenses must be added, in order to develop a bur-dened storage expense. Then, a desired profit margin per-centage is added to create a price per square foot permonth. That price determines the storage rate per unit.
The Importance Of Inventory TurnsBecause storage costs are calculated on a monthly ba-
sis, the total cost of storing an item depends on how long itwill be in the warehouse. In the past, each unit receivedfor storage had an anniversary date with renewal storagecharges added each month afterward. Later billing sys-tems were designed to simplify the clerical task by charg-ing a half month for items received after the 15th of themonth, and a full month for everything in storage on thefirst day of the succeeding month. Regardless of the sys-tem used, an inventory that turns 24 times per year shouldcost less to store than one that turns six times per year. Forthat reason, the inventory turn rate is a critical data pointin creating storage prices.
The “Make Or Buy” FactorNearly all services available from a logistics service
provider can be replicated by an internally managed pro-ject. The buyer who knows the amount of space needed,and has estimated the number of people required to staffthe operation, should be able to simulate the“do-it-yourself” cost of providing comparable logisticsservices. This cost is then compared with the prices of-fered by a logistics service provider. In this situation, therisk factor is critical. The do-it-yourself option is full ofrisk, unlike a unit price agreement that provides maxi-mum flexibility because the risk is absorbed by the logis-tics service contractor.
Living With Hurdle RatesWhen your company makes an investment in logistics
facilities, financial managers want to know about the re-turn on investment. Hurdle rate reflects the minimum per-centage of investment return that is acceptable for yourcompany. If you choose the “do-it-yourself” option, yourreturn on investment will be based on the dollars saved,rather than the cost of contracting the service to anotherparty. Yet, you must recognize the substantial risk of do-ing it yourself, then compare it to the employment of anindependent service provider.
Simulating A Logistics Service ProviderSome private warehouse operators treat their opera-
tions as if they were public warehouses. Transfer costs forinternal storage and handling prices are determined, andthe warehiouse manager is held accountable for profitableoperation at the established rates.
Thomas W. Speh is Associate Direc-tor of MBA Programs at Miami Uni-versity. He also holds a part-timeposition with CSCMP, as Directorof Strategic Initiatives. Dr. Speh re-tired from full-time teaching at Mi-ami's Farmer School of Business in2008, where he taught courses inLogistics and Supply Chain Man-agement for 35 years. He haswoorked on consulting projects in avariety of supply chain areas withmany different firms.
We have tried to maintain a neutral position on contro-versial issues, and avoided any approach that appears tofavor a single political party. That said, your editor hasconcluded that the Employment Free Choice Act, alsoknown as EFCA, or the card check bill, is the most danger-ous legislation proposed in the United States for morethan half of a century. It should not be a partisan issue.
Certain facts are undeniable. Labor unions were an im-portant factor in industrial reformation during the 19thand early 20th centuries; yet, the percentage of the union-ized workforce has declined each year during the past halfcentury. The logistics service industry, like many others,has been transformed from a unionized business to onethat is nearly union free. Labor leaders, facing the pros-pect of extinction, have contributed significant donationsto politicians who agree to sponsor legislation allowingthem to expand. EFCA, for the labor lobby, is payback forpolitical contributions and support.
The EFCA is dangerous for these reasons: First, it willdeny the secret ballot to workers who face a choice ofwhether or not to recognize a union. Second, if a unionclaims recognition and begins to negotiate, a federal arbi-trator will dictate a settlement if no agreement is reachedwithin 90 days.
Unions essentially are a franchise business, and the un-ion organizer is compensated for expanding the group. Ifthat individual is unscrupulous, a variety of illegal tech-niques may be employed to induce prospects to sign a un-ion recognition card. This could, and has, included ha-rassment and personal threats.
There is no law that can force a corporation to remain inbusiness. Thousands of business owners would liquidatetheir companies rather than suffer with a hostile work en-vironment; therefore, passage of EFCA has the potentialto convert the current recession into a second Great De-pression that is worse than 1929.
Two legal scholars, writing for the Wall Street Journal,have expressed the opinion that EFCA is unconstitutionalbecause it denies citizens the right of the secret ballot. Un-fortunately, the test of constitutionality cannot take placeuntil, or unless, the legislation is passed.
The majority of people in this country are union freeand want to stay that way. Our Congress is supposed to re-flect the will of the people. If you believe that EFCA is athreat to our economy, contact your Senator and Repre-sentative, and ask them to reject this legislation.
The Influence Of Future ShockIn 1970, Alvin Toffler broke new ground with his
book, Future Shock. Published in 15 nations, this book in-fluenced the world public, with its message that futureshock is a disease suffered by people who are over-whelmed by change. The real problem was not change,but acceleration of the pace of change.
The recorded history of mankind equals 800 lifetimes,at 62 years each. Of these 800, 650 were spent in caves.Writing has been used only for the last 70, and printingduring the last seven. Most of the products we use todaywere developed during the last two. These events havechanged our world since Toffler’s book was released:
The United States suffered the worst attack on itssoil in our history.Radical terrorists have engaged in a global waragainst the United States and other Western na-tions.The Soviet Union collapsed.For the first time, the United States lost a war.One United States President was forced to resign,and another was impeached.Transportation was deregulated in the UnitedStates.The costs of communicating and computing havefallen drastically.We have suffered the worst economic downturnsince the Great Depression.
During 1970, Federal Express and the expectation ofovernight delivery service was no more than a dream inthe mind of founder Fred Smith. While “just in time” wasutilized in Japan, it was unknown in the United States.Barcode technology had not yet entered the warehouse.ESFR sprinkler systems, which made older systems obso-lete, were not yet introduced. Computers were bulky andexpensive machines, and the warehouse management sys-tems we use today did not exist.
The web-based technology, which is used widely inwarehousing and other business activity, was unknown in1970. The concept of the lean organization had not yetbeen developed. While processing of returns always was anecessary evil, the concept of reverse logistics had not yetbeen introduced.
The Growth OfA Flexible Workforce
As the economy recovers, warehouse operators mayelect to use staffing service employees rather thanfull-time workers. Others will use permanent part timers,such as college students, who are unwilling to take a fulltime job.
If there is a downturn in volume, the flexible workersare the first to be cut. This provides increased stability tofull-time workers, which can be a positive morale factor.
EFCA --A Threat To
Private Enterprise
VOLUME 24 • NUMBER 7 • jUNE 2009
2009
VOLUME 24 • NUMBER 7 • JUNE 2009
Understanding Warehouse Costs and RisksBy Thomas W. Speh, Ph.D.
Editor’s Note: Presented here is a revision of an article writ-ten nearly two decades ago by professor Tom Speh, of MiamiUniversity, Oxford, Ohio. When written, the purpose of thiswork was to provide a guideline for public warehouse opera-tors and their customers. Both buyer and seller were accus-tomed to a transactional pricing and costing system thatcombined a monthly price per unit for storage with the costs ofmaterials handling and administrative services. The vendorneeded to make certain that this pricing would yield a profit,and the buyer wanted to be sure that no money was left on thetable. In revising this work, we recognize the need to create amechanism that is useful for wholesale distributors, as well aslogistics service providers who are not using unit pricing.Both buyer and vendor need to understand the process, in or-der to compare price to actual value of the services rendered.KBA
Warehousing is nothing more than the management ofspace and time. The space management portion, storage,has a cost per month, because there is a monthly cost forwarehouse space. The time management component in-cludes labor involved in handling materials as they movein and out of the warehouse. If you are buying or sellingwarehouse services, or simply providing warehousingservices for your own organization, the models that arepresented in this article will enable you to isolate and ana-lyze the costs of warehousing.
All companies with warehouses incur the same ele-ments of cost, but they compile them differently. The goalof this article is to convey a costing system that can beused to compare costs of one warehouse with another, orone company to others.
Some warehousing costs tend to be ignored ormisallocated, because the analyst does not recognizewhere they belong. In any costing system, allocation ofoverhead costs is a matter of judgment, and no specificformula will be correct for every user. The cost modelsshown here have been designed to ensure that no item isoverlooked. We assume that each user will customize themodels, and make individual judgments regarding alloca-tion of administrative costs.
Four Categories Of Warehouse Costs1. Handling. All expenses associated with moving
product in or out of the warehouse should be included in
the handling cost center. The largest component is the la-bor used to handle the product that moves through the dis-tribution center. It includes receiving, put-away, order se-lection, and loading. It also may include labor tore-warehouse, repackage, or refurbish damaged product.
Handling also includes all costs associated with theequipment used to handle product in the warehouse, suchas the depreciation of equipment cost, and the cost of fuel,or electricity to power the equipment.
Other handling expenses are the detention of truck orrail cars, operating supplies, and trash disposal. In effect,handling includes all those costs that are associated with“goods in motion.”
2. Storage. Storage expenses are costs associated with“goods at rest.” These costs would be incurred whether ornot any product ever moved. Because storage expensesare related to the cost of occupying a facility, and thesecosts are normally accumulated each month, storage is ex-pressed as a monthly cost. If an entire building is dedi-cated to an operation, storage expenses are the total occu-pancy cost for that facility.
3. Operations administration. These expenses are in-curred to support the operation of the distribution center.Closing the facility would eliminate these costs. Includedare costs for line supervision, clerical effort, informationtechnology, supplies, insurance, and taxes.
4. General administrative expenses. Expenses not in-curred for a specific distribution center are included inthis category. General management, nonoperating staff,and general office expenses are examples. Allocation ofsuch expenses to each warehouse is a judgment call.Productivity Improvement
Most warehousing costs, particularly storage and han-dling, can be influenced by improvements in productivity.Improved methods and equipment may enable the opera-tor to increase the number of units moved without increas-ing labor, resulting in a higher number of units handled perhour. Changes in inventory, storage layout or equipmentmay enable the operator to expand the number of unitsstored in the same number of cubic feet of storage space.The Risk Factor
Cost per unit is escalated when a distribution center isnot fully utilized. Fixed costs always will be influenced bythe rate of utilization. Variable costs, such as labor, never
What Only the CEO Can DoBy A.G. Lafley, Harvard Business Review, May 09,pg. 54
Most people consider the chief executive to be acoach and/or a problem solver. The author, of this ar-ticle, CEO of Procter & Gamble, views the job differ-ently. Only the CEO can link the external world withthe internal organization, and that must be done, be-cause without that link the company cannot succeed.Lafley recognizes these four tasks of the CEO:
Define the “meaningful outside.” How do weconnect with the ultimate consumer?Decide what business you are in. At the sametime, determine what businesses you shouldnot be in.Balance present and future. Consider bothshort-term and long-term goals and results.Shape values and standards. Are they relevantfor both today and tomorrow?
WMS: A Blueprint For SuccessBy Chris Werling, Parcel, March 2009, pg. 30.
Written by an independent consultant, this articleserves as a useful primer for implementation of ware-house management systems.
The first step is testing, ensuring that every aspectof the system functions as expected. Training shouldstart early, and include those on the warehouse flooras well as the office staff who work with the system.The timing of conversion, the process of moving datato the new system, may be critical. Validation is a sec-ond test to confirm that everything is on track. Themost common mistakes in implementation resultfrom poor planning, improper training, and/or inac-curate item analysis.
Cost-Saving Strategies for ContractsBy J. S. Millstein and Tim Roughton, CSCMP’s Sup-ply-Chain Quarterly, Quarter 1/09, pg. 34.
The authors of this article are lawyers in the NewYork and London offices of a corporate law firm.They addressed four areas that offer opportunities toimprove outsourcing contracts with new ways to cutcosts. The four areas are flexibility, enforcement ofcontractual rights, renegotiation and leverage. Re-garding flexibility, they stress the importance of rec-ognizing the price of superior service. Don’t ask foror agree to service requirements that truly are notneeded. In these difficult times, a dispute resolutionprovision is an important part of every outsourcingagreement. Changing economic conditions may sig-nal the need to renegotiate terms that were acceptableprior to the current recession.
Finding New Value In Truck Leasing,By Gene Scoggins, Inbound Logistics, April 2009,pg. 26.
The author, president of NationaLease, a majorprovider of leased motor trucks, focused on transpor-tation equipment in this article; yet the same argu-ments apply to lift trucks, and other capital equipmentused in warehouses. Some advantages of equipmentleasing include the following:
P Conserve capital to grow the business. Yourdollars might earn more with many other in-vestments.
P Manage credit. In today’s banking climate, fi-nancing of equipment can be challenging.
P Avoid depreciation losses. Leased equipmentis not depreciated.
P Control maintenance costs.
Compliance EducationBy Chris Gillis, American Shipper, March 2009, pg. 9.
Managers who are ignorant of federal regulationsgoverning import and export activities run the risk ofincurring severe penalties and unwanted publicity.The World Academy, based in New Jersey, offersthree-day compliance seminars for shippers and lo-gistics service providers. More information is avail-able at www.theworldacademy.com.
Motivating Your Staff During A Down EconomyBy John Brown, Material Handling Management,May 2009, pg. 44.
When a California trucking company faced theneed to reduce salary expenditures by 20%, manage-ment elected to adopt a four-day work week ratherthan resort to a layoff. At the same time, the companylaunched a training program conducted by a profes-sional business coach. The six-week program was en-titled, “Battling Burnout and Regaining Control.”Many of the sessions were forum discussions that per-mitted workers to express their fears and anxieties.The CEO stated, “I was pleasantly surprised at howmuch they helped me cope with the stress of leading acompany during this economic storm.”
Logistics Bright SpotsAmerican Shipper, May 2009, pg. 16.
An increasing number of logistics service provid-ers are using solar energy to power their facilities.Warehouse roofs are ideal for solar panel installationsbecause they offer large expanses of access to sun-light. All of the examples provided in the article arefrom facilities on the Pacific coast.
