Distribution Lingo Spelled Out
B2C: Business to Consumer
DC: Distribution Center
DRP: Distribution Requirements Planning
DSD: Direct Store Delivery Model
FTZ: Foreign trade zone
LTL: Less than truckload
NDC: National Distribution Center
NVOCC: Non-vessel operating common
RDC: Regional Distribution Center
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The April 16 issue of The Kiplinger Letter posed a question that would send a chill down the spine of any industrial developer: "Are warehouses becoming obsolete" Kiplinger wasn't talking about old-style buildings becoming obsolete. Rather, they were talking about distribution strategies that ship products to retailers/customers directly from factories or port terminals, eliminating warehouses and distribution centers from the equation entirely. According to Kiplinger, "Soon, about half of all products will sidestep warehouses. Nearly 40 percent already do. Low-cost satellite and Internet tracking systems are helping to make it possible for companies to cut their delivery times and hold down costs". The trend is not good news for warehouse operators, of course. Or for commercial real estate in general."
The Big Squeeze Is On
It is no secret that retailers are always looking to stream-line distribution and reduce warehousing as a way to contain shipping costs. "There is activity now to bypass warehouses and go as directly to the customers as possible and take a step out of the process," noted John Platz of TZA Consulting, logistics experts.
Called direct store delivery (DSD), this model would be similar to "stop-off" shipment strategies already in use by domestic vendors to move high volume, fast moving, seasonal products, like charcoal or the salt you use to melt ice on sidewalks.
Rather than run large shipments of these commodities through a distribution network, trucks take the order from the manufacturer directly to individual stores. Stop-off shipments may handle five or six orders and deliver to a mix of retail stores or to multiple locations of the same retailer - all without a distribution center or warehouse involved. Michael Peters of ProLogis observed that areas of the direct store delivery supply chain have been improved as of late, with manufacturers working hard to provide more "build to order" capabilities and retailers looking for new opportunities to implement such deliveries.
Until now, this direct shipment model only worked for a select type of mostly seasonal products. However, both FedEx and UPS have entered the market with new direct distribution services. For example, in August 2002, UPS Supply Chain Solutions launched its Trade Direct Ocean service, designed to move goods directly from ports in China and Brazil to customers and retail locations, bypassing distribution centers in the United States. UPS sees this service as targeted to products like "large apparel, sporting goods, electronics and other companies that utilize ocean as an economical transport mode and want order delivery direct to their customers."
According to the UPS Web site, here's how it works:
- Customers deliver shipments to UPS Freight Services centers in Brazil and China.
- Small packages destined for U.S. customers and retail locations are labeled, then put in ocean containers.
- Ocean containers are transferred to ports and placed
on ships, booked by UPS Ocean Freight Services, which
is an NVOCC (non-vessel operating common carrier).
- Upon arrival at the ports, UPS finalizes international trade documentation and customs clearance requirements.
- From containers, small package shipments are deconsolidated, then travel across the U.S. via UPS's rapid ground or air network. Shippers and customers
can then track their shipments via the Web. (Less-than-truckload service also is available.)
- Throughout the journey, UPS tracks by item, carton or shipment level.
One of the main selling points, according to UPS, is the ability of this streamlined process to bypass multiple distribution centers, minimizing the need for shipper-owned warehouses. UPS also touts other benefits to shippers, namely that Trade Direct Ocean minimizes handling, which potentially means less loss and damage, and less time in transit. The company estimates current savings of two to 20 days. Indirect benefits include speeding up a company's cash flow because inventory is moving faster from factories to end customers.
Are Tenants Signing On To These New Distribution Strategies?
So, what are the downsides to strategies that bypass warehouse and distribution systems? (To find out, we approached the 800-pound gorilla of retailers Wal-Mart. However, citing confidentiality of their logistics strategies, Wal-Mart declined our request for an interview.)
Moving up the distribution chain, we contacted Hillwood, an industrial developer who is working on a deal with a "major Wal-Mart supplier" for a 200,000-square-foot warehouse and distribution center. Discussing the direct store delivery model, David Pelletier wondered why major Wal-Mart suppliers would continue to take large space like this if they are supposedly moving away from warehouses.
Although Pelletier hadn't heard about the UPS/FedEx direct ship strategies, he didn't think they will catch on because retailers have a need for redundancy to guard against "stockouts," or empty shelves in stores. Pelletier feels that a system like UPS's Trade Direct Ocean offers
no alternative warehouse or distribution center options if something goes wrong on the main route.
He foresees a trend toward having redundant facilities, in the event that some type of distribution interruption, like a terrorist attack, the East Coast blackout or the West Coast port strike, occurs again. "We're depending on a constant flow of goods, but they learned that they have to have capacity within the U.S.," he said. "In a perfect world, everybody would want to go direct. But it's not realistic. Any hiccup along the line and your shelves are empty.
And retailers wouldn't like that. "Increased sourcing in Asia will make it more difficult to implement direct store deliveries", said Peters of ProLogis. "Currently, a store can look at its inventory levels and ship product from its distribution centers to arrive in less than three days to replenish the shelves," he said. "If they are depending on a direct store delivery from China, the replenishment time hovers around 30 days."
Patrick Gallagher of the Alter Group gave the example of a container of dresses made in Asia. "I don't think it is possible for the sealed container of dresses to leave Asia and be shipped without a stop, to a local Wal-Mart store. Somewhere along the line they have to open
the container."
However, he allowed that RFID (radio frequency identification tags) will definitely change the ways products are shipped. Wal-Mart has made public its near-future plans to require their major suppliers to have RFID tags on each individual product. To use the dress analogy again, by using RFID, Wal-Mart can track which color sells better, in real time. For future orders, they will tell their supplier to only manufacture the best-selling color. Taking advantage of these efficiencies, Wal-Mart can now opt to ship these dresses via air. Although it is more expensive to ship products that way, they can justify it because they have already cuts costs by reducing the need to warehouse products.
Sean Maher of CenterPoint Properties Trust sees a more dramatic shift not in a decrease of warehouse demand, but in who actually is involved in the ownership
and distribution of goods. Maher reasoned that more national retailers are cutting out the wholesale market and contracting directly with manufacturers abroad for direct shipments to their own distribution centers, allowing them to monitor the supply chain and shrink the time from point of order to point of sale.
"Retailers are smart - the more a product is handled, the more the price goes up," Maher said. "They still have a demand for space, but eliminating the wholesaler step
is a better way to control inventory and keep costs down."
Alter Group's Gallagher agreed. "We may see subtle shifts, but someone along the line - perhaps it is FedEx or UPS " will be the recipient of an increased need for warehousing and distribution," he said. "Whoever the carrier is has to have its own distribution facilities. At some point, the shipment has to be broken down into local deliveries." TZA's Platz concurred that there will always be a need for a warehouse, although the demand may not be as big. Platz recalled when automotive manufacturers announced that they wanted to do away with their DCs and have vendors provide them with daily, just-in-time shipments of products. "Warehouses didn't go away. They just changed. In order to make sure that products always arrived on time, it became necessary for product manufacturers to build new warehouse space a mile or so from the automotive plants."
Finally, Platz pointed out the 80:20 rule. "Direct shipment will only work for a certain percent of the products being shipped, and a certain percent of the retailers receiving them. It's the 80:20 rule - what will we do with the products that don't fit the profile for direct shipping" They will have to go to distribution centers and warehouses."
What Will, and Will Not, Change
Ed Frazelle of Logistics Resources International sees two main trends that are improving cost efficiencies in the logistics supply chain, which could result in incremental reductions in demand for industrial space: Web-based logistics and collaborative planning. "E-logistics are making it less expensive to connect every point in the supply chain to every other point," said Frazelle. "It comes down to two key factors - increased CPU transactions per second (computing capacity and speed) and lower cost per CPU transaction."
All in all, the logistics experts and industrial developers interviewed for this article did not envision major changes in the location of distribution centers. Platz explained, "Distribution centers will still be located in the major cities because that's where the people are. You want to get as close to the end customer as you possibly can. I don't foresee it shifting to different areas."
Platz noted, however, that sometimes the cost of doing business in a major city will make it cost-efficient for new distribution centers to spring up in a related area outside the city they serve. For example, Reno and Las Vegas now serve the California market; the savings in taxes and labor offset the increased transportation costs of shipping goods to Reno and Las Vegas and then back to California cities.
More Influencing Factors: FTZs and Mounting Fuel Costs
Ken Smith of IDI noted a new surge in the development of market distribution supply centers in foreign trade zones (FTZ) that allow distributors to move products across the county without paying import fees.
Smith used the example of a product manufactured in China and delivered to a foreign trade zone warehouse built in the Midwest. After the containers are offloaded at a West Coast port, they are shipped eastward via truck, skipping one warehouse step altogether.
As long as the goods are kept in sealed containers and delivered to foreign trade zone warehouses, they are in essence still considered to "be in China.- No import fees are paid, no daily tracking reports filed. The import fees begin when the container is opened and distribution begins.
If a U.S. retailer brings goods in to the county via a foreign trade zone warehouse and never cracks the containers and then ships the goods out of country, no import fees are paid at all. The container has basically gone through a foreign supply chain and no import duties are ever due.
An article in the Winter 2003 issue of Development supports the Foreign Trade Zone theory, noting that the program is gaining momentum as an increasing number of U.S.-based companies are refining their global supply chain strategies. With more than $200 billion in value of merchandise received in U.S.-based foreign trade zones annually, the program offers importers and exporters the opportunity to reduce costs and expedite import/export cargo movements.
Another wild card in the distribution game could be transportation costs, especially skyrocketing gasoline costs. As Frazelle explained, "Forms of transportation depend heavily on fuel costs, and higher fuel costs can shift transportation to less expensive transportation modes (i.e., ocean vs. air; truck vs. air; rail vs. truck)." On the other side of the equation, "Higher customer expectations will shift transportation to more expensive transportation modes. You really need a matrix with fuel costs, inventory carrying rates and response time requirements to determine appropriate transportation modes."
CenterPoint Properties" Maher agreed, noting that rail is becoming more efficient and timelier in its shipment of goods. "Shipping by trains continues to be one of the cheapest means of transportation for long haul," he said. "Trucks are more efficient for short hauls. Time sensitive goods - electronics, health care, small parts - continue to drive air cargo."
Cautiously Optimistic About the Future
We can take heart from Frazelle's current assessment of the distribution game: "Warehouses are growing in size - counter to what reductions in inventory and design-for-productivity would suggest." Maher concurred with that assessment. "As long as America continues to be the largest consumer of goods in the world, and goods are brought in to the U.S. for consumption, there will need to be warehouses for storage," he said. But industrial developers should stay alert for future shifts. Hillwood's Dave Pelletier cautioned that you need a crystal ball to cope with these fast-moving changes in distribution strategies. "Every company has a different outlook on logistics, and they change it all the time," he said. "It's like the weather, you wait a minute and it will change."
Sheila Vertino is NAIOP vice president of information and research. Kathryn George is NAIOP communications director.
For more information
"Industrial Space Users Gaining Competitive Edge in FTZs" http://www.naiop.org/developmentmag/features/indexee.cfm
Logistics Institute at Georgia Tech
http://www.tli.gatech.edu/
