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A No-Hype Guide to Network Optimization
Connect, Spring 2008
With companies looking to lower supply chain operating costs while simultaneously increasing customer service levels—coupled with the downright painful rise in fuel costs—many are turning to network optimization as a key strategy to obtain these twin objectives.
But is network optimization really the cure for supply chain ailments?
“The output results of a network optimization study will always lead to lower total operations costs within a supply chain,” promises Charlie Rizzo, Vice President of Client Services Improvement for FORTE.
“The question is: do the savings achieved by the future state network identified by the process justify the investment that you may need to make,” he explains. “The results of a network optimization are not hype, but there needs to be a good, solid business decision behind the impetus to move forward.”
Three Indicators of When a Network Optimization Is Needed
Rizzo notes that companies who will benefit from a network optimization project typically feel significant pressure in at least one of these three areas:
Freight Costs |
If your annual freight spend exceeds more than $5 million for both inbound and outbound freight combined. Most network optimizations will yield a freight savings of 10-15%, an attractive potential savings.
Excessive intra-facility transfers to replenish low inventory at one distribution center (DC) with surplus inventory from another. Although the savings in time (as it’s typically quicker to move on-hand product rather than order a fresh supply from the source) may seem to justify the cost, some companies would be shocked to see the actual annual freight bill for this type of shipping, says Rizzo. |
Customer Service |
Unhappy customers will always let you know, either verbally or by simply taking their business elsewhere—resulting in a loss of market share. Buyers demand better customer service because they’ve grown accustomed to one or two day service levels. |
Operating Expenses |
A distribution operating expense ratio above 3-3.5%—including inbound/outbound freight and DC operational costs (variable by industry) as a percentage of cost of goods sold (COGS)—begs for a network optimization as a means to cutting those costs.
- For high value products (such as medical or high tech) this will be a lower threshold percentage.
- Mass marketed products could have a higher threshold percentage.
The type of picking utilized at the facility (heavily pallets versus heavily split case, for example) will have an impact on operating expenses as well. It will also impact the threshold percentage, since you can move a lot of pallets with less labor cost than intensive split case order fulfillment. |
Network Optimization Considerations
So you’re feeling the pain of one (or more) of the above three scenarios. Now what?
First, says Rizzo, consider your customer service level requirements. “For example, if you get an order in by 3:00 p.m. today, does it need to ship by the end of today or sometime tomorrow?” Rizzo asks. “And, once it ships, does your customer require 1-, 2-, or 3-day service levels for the transportation? Both are important parameters.”
Once the customer service level has been defined, then it’s time to begin the network optimization study. Two additional components of importance—as noted above—are freight costs (inbound, outbound and intra-facility) and DC operating costs.
Next, collect and analyze a full year’s worth of data. That information will be used to project a future scenario spanning about five years. “Factor in what you know to be planned for the future,” says Rizzo. “Maybe you’ll be adding 10-15 new retail stores a year, which yields 8% growth in years 1-3, but just 5% growth in years 4-5. Or, in three years, your company intends to acquire a company in a related field, resulting in a 20% spike in shipments.” This information will help to generate the future state model.
Look for patterns in the data. A seasonal business may handle 60% of its volume in October, November and December, and the other 40% spread through the other nine months of the year. Alternately, a medical supply company may experience steady volume year-round. If your market is highly seasonal, another consideration is if there will be a ready pool of temporary labor in the candidate locations.
Once all the inputs are crunched by the system, the network optimization will enable the modeling of multiple “what if” scenarios. For example, notes Rizzo, “by holding one DC location constant, where should the others be located to maximize geographic responsiveness while minimizing freight costs? Or, what level of cost savings would result from the consolidation of two current, inefficient DCs into one new one that incorporates an efficient flow and appropriate current technologies?” These kinds of evaluations and analyses are made possible by the network optimization process.
A network optimization will not, however, yield a crystal ball prediction of inventory volume requirements on a week-to-week or month-to-month basis, Rizzo cautions.
“If you want to do that, you need to do an ‘inventory optimization’ study, which is a totally different type of mathematical solution,” he explains. “I think there may be some confusion surrounding the similar names for two different processes—an inventory optimization study is something that considers recurring periods throughout the course of a year (perhaps monthly) and optimizes inventory levels for each of those periods individually.”
Conversely, continues Rizzo: “Network optimizations are not that granular. They’re much more long term, broad scale and focus on a total year of activity.”
Reap Those Rewards
Aggregating the cost savings related to labor, freight and facility operations, companies that conduct a network optimization can benefit from overall supply chain cost reductions of up to 20%.
“Companies that invest the time in a network optimization can realistically expect to see labor cost savings up to 15%, freight cost savings up to 15%, and facility operating expense savings up to 25%,” notes Rizzo.
The possible benefits are multi-fold. By reducing the number of DCs, for instance, reserve stock and redundant inventories are reduced. Also, cutting the number of facilities correlates directly to curtailing a corporation’s carbon footprint.
“If you cut freight spend from $15 to $13 million, that’s roughly 13% less fuel being burned moving product either into or out of your DC and to your customers,” Rizzo observes.
Additionally, a network optimization can drive improved service in weaker territory penetrations by highlighting geographic regions that are not well served by the current supply chain.
A caveat about the benefits, says Rizzo: “When you’re conducting a network optimization, it is truly a long term strategy investment—it’s not all just a quick fix. A network optimization will produce results that typically require anywhere from 18 months to four years to fully implement.”
However, initial payback for the first phase of the solution implementation will kick in within one to two years. “A network optimization solution is typically rolled out over a period of time, usually in three to four phases. Consequently, that first phase almost invariably generates significant cost savings very quickly,” Rizzo explains.
So now that the hype has been tempered with truth, there’s one more element that should be kept in mind when undertaking a network optimization: commitment. A network optimization should be an on-going process undertaken semi-annually or annually, advises Rizzo. However, he rarely observes a commitment to the process in his years of working with corporations in a variety of industries.
“The reality is that most companies go five to seven years between attempts to do a network optimization,” he says. “The market today is so dynamic that methods of shipment, order profiles, service levels and products handled change all the time. By the time five years have elapsed, a company has become very inefficient, and probably doesn’t even realize the profound effect it has on their bottom line. In a weak economy there is no other tool that produces as large a performance improvement as network optimization.”
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