The Future of E-commerce Fulfillment Centers
By: Ron Derven, contributing editor to Development magazine
This 1.04 million-square-foot e-commerce fulfillment center is part of Duke Realty’s 600-acre AllPoints at Anson industrial development in Boone County, Indiana, near Indianapolis. Photo courtesy of Duke Realty Corp.
How will the fulfillment centers of tomorrow differ from those in use today?
SIX MEMBERS OF NAIOP’S National Forums offer their insights on the future of e-commerce fulfillment centers, including a look at “must-have” features; the impact of incentives on location decisions; the growth of smaller, close-in facilities in addition to mega-centers; the future role of third-party logistics providers; the impacts of technology; and more.
What are the “must-have” features for e-commerce fulfillment centers (FCs), both now and in the future?
Jonathan Tratt: There are a couple of required features for an e-commerce facility going forward, including additional car parking over and above that found at a traditional industrial warehouse (most large Amazon facilities have 15 to 20 acres of additional land [for employee parking]); clear height of 36 to 40 feet; and enhanced load-bearing capacity for warehouse floors as mezzanines get stacked three and four levels high, as well as increased load-bearing capacity for roofs to support large air-conditioning units and material handling equipment. Together, these features could add $1 or more per square foot in construction costs.
Ben Conwell: Forty-foot clear height will become more standard. Depending on local land and construction costs, building vertically to create additional cubic space can be more cost effective than building horizontally. Greater clear height also will delay the built-in obsolescence that is inevitable with advances in technology. Given material handling designs today, not everyone will immediately take advantage of the full 40 feet, but increasing advances in MHE [material handling equipment] technology will allow for more throughput in these buildings. These facilities commonly require large parking and circulation areas for workers, trucks and trailer storage. Large shift sizes all require more space for break rooms and administrative space.
Rene Circ: Think of these buildings as little manufacturing facilities where people make boxes filled with random stuff. This is the reason that these buildings have become more accepted by local communities. In the old days, distribution buildings created a lot of truck traffic, but very few jobs; today, distribution buildings create a lot of truck traffic and a lot of jobs.
Scott Lamson: Customers want a minimum of 8,000 amps of power with the ability to increase the power supply to the building. They want dedicated truck access and secured truck yards.
Mark Hosfeld: A counter-trend to all this is that e-commerce companies need to get closer to the end user and reduce that “last mile” delivery cost. For the last mile, they need smaller buildings with smaller parking lots and smaller truck parking areas. These are more sortation-type buildings that allow product to speed through the facility quickly.
Are incentives offered by states and municipalities affecting where new FCs are developed?
Conwell: These facilities are commonly large employers and can be significant tax revenue generators, so incentives offered to offset construction and operating costs can be a good long-term investment for local and state governments. For tenants, incentives make a good location decision better. That said, incentives are an important part of the calculus, but they are not the No. 1 driver.
Hosfeld: Some parts of the country — like California — simply will not provide incentives. But clearly, many communities are trying to attract e-commerce companies and incentives are a key part of that. If you are deciding between a location in the Midwest or the South where you can easily go from one city to another, then incentives become a more important part of the equation.
Kris Bjorson: Yes, but remember that incentives are probably the fourth or fifth item of importance. Incentives are the icing on the cake that makes a good deal in the right location better, but they will never make a bad deal in the wrong location good.
Will the shift from supersized FCs in centralized locations to smaller facilities closer to population centers create new opportunities for adaptive reuse of older warehouses and other types of properties?
Lamson: Yes. Location is the main driver for these last-mile delivery centers. Companies use these locations for trans-loading rather than traditional warehousing. Thus clear heights and oversized truck courts are not as important. This creates more opportunity for the re-use of existing buildings in infill areas.
Circ: There are many smaller buildings that may not be perfectly located, but they will be close enough to infill locations. The beauty of going into one of these close-in buildings is that they do not need to be anything special. Suddenly, Amazon or one of the other e-commerce companies is not a unique company with unique requirements, but rather just like any local distributor looking for a building.
Tratt: Yes and no. E-commerce companies will seek out these infill locations in large, high-density metro markets, like those on the East Coast. Looking at the country as a whole, there are probably only a handful of markets where retailers will pay a premium for that infill location.
Conwell: We see older, obsolete product being taken solely based on location, because leading-edge players do not want to take the two-and-a-half years needed to redevelop an obsolete site. On the other hand, if a property owner has an opportunity to redevelop an obsolete 200,000-square-foot building into a very functional property in an A-plus, close-in location, it can be a win-win on all counts. We see increasing activity from investors and developers targeting capital to respond to these needs more deeply into metropolitan areas.
What roles are third-party logistics providers (3PLs) playing in e-commerce?
Lamson: Other than the trucking and delivery companies, the standard 3PLs are not playing a major role in this sector. However, due to the overall costs of implementing an e-commerce delivery strategy, we expect the role of 3PLs to grow as more companies begin to expand their e-commerce businesses.
Tratt Properties, LLC, completed the 395,000-square-foot 43rd Avenue Logistics Center in Phoenix in April 2014. The building was sold to a national investor.
Photo courtesy of Tratt Properties, LLC
Circ: Amazon today is serving as a 3PL for a lot of small e-commerce businesses. So Amazon’s share of that business will continue to grow. At the same time, Amazon is less likely to [outsource to other] 3PLs. Third-party logistics providers are about cost savings and efficiency.
Conwell: The 3PL industry is on the cusp of significant growth and disruption. With the exception of Amazon and select others with significant infrastructure of their own, retailers will be compelled to utilize 3PLs to perform some or all of their e-commerce functions.
Hosfeld: Third-party logistics providers are a rapidly growing phenomenon because a lot of traditional retailers don’t have the expertise to do their own e-commerce fulfillment. It is a totally different channel than what they have for their stores, and they are seeking the expertise of 3PLs to give them that knowledge and run those operations. We are just on the cusp of this.
How is technological innovation impacting the space needs of FC tenants?
Tratt: The two greatest impacts of technology are robotics and cube utilization of the warehouse [use of both vertical and horizontal space]. Full utilization of the cube is something that many companies did not do in the past in general warehousing and distribution.
Conwell: Enhanced use of robotics and other automation is creating greater throughput per building square foot, cubic foot and labor hour. This drives a different design of what happens inside the building, which then directly impacts the shell, the dock doors and product flow operations. What makes a fulfillment operation successful is not how much “stuff” you can store in the building, but rather how much volume of throughput you can achieve, especially during peak weeks. Increases in efficiency and throughput can drive reductions in building square footage. Advances in supply chain technology that improve delivery speed to and from FCs, optimize inventory planning and lower costs are just as impactful.
Are mega-fulfillment centers still being built at the pace they were two years ago?
Circ: It will have to slow down at some point, but the wild card today is, who else feels that they are behind the curve? Target and Walmart.com are way behind the curve because they started online fulfillment much later than Amazon. New construction of mega-fulfillment centers will play itself out at some point, but not right now, as other big names jump in.
Tratt: Construction of million-square-foot facilities is not as prevalent as it was a few years ago. The biggest reason is that Amazon has reached a certain level of coverage in their fulfillment network; it is not absorbing the same amount of industrial space as it did from 2012 to 2014. However, there will be continued demand for the million-square-foot warehouse for e-commerce in major markets.
Bjorson: No, not at this moment [in March 2016], although I would say 100 percent of retailers are analyzing their direct-to-consumer and e-commerce business but only 40 percent of them have actually implemented e-commerce strategies. The mega-fulfillment centers have been primarily completed by the largest retailers with the most stock keeping units (SKUs), who require more space. Given that there is a long runway of companies yet to implement their e-commerce strategies, we will continue to see more fulfillment center deals in the future, though they may not all be mega-FCs.
Has the number of retailers fulfilling online orders from brick-and-mortar stores increased?
Tratt: Yes, it is on the increase and is expected to continue to grow, as certain retailers have still not adapted and are late to the party. Their only significant growth will be through e-commerce.
Conwell: We have only seen the beginning of true “click and collect” (buy online, pick up in store) or “ship from stores.” For most traditional retailers, this may be their most powerful — or only — point of differentiation from their pure-play online competitors. Click and collect and ship from store are easy to say, but extremely difficult to execute properly. These concepts are driving changes to store layouts, inventory planning, labor and the entire supply chain.
A national retailer told me in January 2016 that the holiday click and collect experience at his company’s flagship store was monumental; that is, it was monumental in terms of customer response and how much work it was creating for the retailer. That retailer had to quickly hire 150 fulfillment workers just to handle click and collect inside its main store. The National Retail Federation reports that 40 percent of online shoppers made at least one store pick-up using click and collect during the 2015 holiday season. Lessons from that holiday season are being rapidly implemented. Click and collect has just begun.
Bjorson: Yes, retailers are continuing to find efficient and profitable ways to ship merchandise from the store to the consumer. There is a relentless amount of analysis taking place to determine which SKUs should be sent from the FC and which from the store, based on inventory availability/visibility, service level and cost.
What are the biggest challenges ahead for e-commerce retailers and property owners who lease space to them?
Lamson: The challenges depend on location. For infill, last-mile locations, the biggest challenge is the availability of functional real estate. For the more traditional distribution centers, increased development costs and finding the appropriate site with the right labor pool continue to be a challenge. Despite these challenges, our business continues to expand because of e-commerce and supply chain modernization trends.
Circ: For property owners, a big challenge will be the large buildings constructed in nontraditional distribution markets like Richmond, Virginia. There is no guarantee that a company like Amazon will renew those leases [in the face of] continuous supply chain reconfiguration, technological innovation, new trade routes opening or other changes. Just because Amazon needed that big warehouse in 2012, that does not mean it will need it in 2025 when the lease comes up for renewal. Who will be the next tenant?
Tratt: The biggest challenge for e-commerce retailers going forward is the consumer’s demand for instant gratification, which has quickly become the norm thanks to our friends at Amazon. Before e-commerce came into its own in the last 10 years, people would order from a catalog and received the merchandise in a week or two, which was the norm and acceptable. Today, that is the biggest challenge for e-commerce companies. On the property owner side of the business, I don’t see challenges, I just see opportunity! I am focused on gearing my business toward e-commerce users because they have a tendency to make a bigger commitment into the space in tenant improvements and therefore have a longer-term perspective and are not averse to signing 15- and 20-year leases. I am of the old-fashioned mindset that the longer the lease, the better.
Hosfeld: One of the big challenges is trying to find an adequate labor supply to operate at seasonal peaks. It is hard for e-commerce companies to find the right sites that fit all of their requirements.
Bjorson: Flexibility. Our clients are concerned about flexibility and the ability to expand and contract as their e-commerce product mix and service levels continue to evolve.
Conwell: The big riddle remains, how fast is fast-enough delivery? Amazon has us all addicted to instant gratification: it has trained us that if we click, they will get it to us in warp speed at no additional cost. Retailers need to understand the ideal balance between speed and cost for their value propositions. They are having to innovate and adapt at a faster pace to avoid falling further behind Amazon. Rethinking the supply chain, branding and the store experience are just some examples. Property owners need to be nimble and flexible enough to accommodate changing user design requirements, be open to creative financing for above-standard improvements, and be willing to rethink the paradigm of where logistics real estate is traditionally located.