Topic 8.

Warehouses and Distribution Centers

Companies, by expanding their operations beyond their primary location, must resort
to installing strategic centers aligned with the companies’ expansion objectives.

Traditional relations of a distribution chain are the following:

In this scheme, each link maintains some levels of inventory at strategic places to cover
the needs of the following link, this aimed at the end product reaching the consumer
hands in time and form.

What determines the location, size, characteristics, or capacities of distribution centers?

Company decisions are based on the market and the alignment with their strategic
objectives.

How would you designate a strategic distribution center? What factors would you
consider?

Explanation

8.1 Principles of storage

Supply or sourcing is defined as a set of activities with the objective of ensuring

availability of goods and services offered by companies to their customers. The set of
activities includes planning, order placement, materials management, and control.

Once the requirement of the organization has been determined through inventory
planning, it is necessary that the plan is set into action through distribution strategies.

Channels of distribution comprise the flow of goods, services, information, and finance;
from obtaining the product until it reaches the end consumer. For that the intervention
of different intermediate participants is necessary, such as distributors, wholesalers,
retailers, carriers, and insurance service providers.

To comply with distribution objectives, companies develop strategies where they

designate concentration points in the channels, called distribution centers. The
principles of storage or distribution centers are the following:

Distribution centers, or warehouses, are

strategically located places, with special facilities and capacities to accumulate the
company's inventories. A company may have as many distribution centers as it deems
necessary, based on its operation strategy.

Location of storehouses has a specific purpose, which may be supplying a specific

region, being part of an important client’s supply chain as a strategic vendor, storing
product near a port or hub of a carrier company, leveraging fiscal benefits granted by
the government, or of weather conditions to protect susceptible materials, just to
mention a few strategies used by companies.

Another catalyst for storage in an organization, in addition to anticipating market

demand, are economies of scale. Economies of scale are defined by Parkin (2001) as
“characteristics of a company's technology leading to decreasing average cost in the
long term as production increases”, that is, is based on the premise that as assets and
productive resources are used more in a determined time, there will be efficiencies that
will reduce the per-unit cost of output. During the logistics process of supply chain
there are three points where a company may generate economies of scale: supply,
production, and transportation.
Accumulation due to economies of scale refers to storing product that will not be used
or sold soon, however, a company decides to purchase or produce it to reduce their
per-unit cost. For instance, it is possible that a vendor will have a promotion if the
purchase volume is higher than the minimum required by the company; or the
company has to pay freight and decides to place an order for a greater quantity to
optimize the space in the truck or container; or a company may decide to produce
additional amounts to leverage the fixed costs of their output capacity, and distribute
these fixed costs in a higher production volume.  Each of these situations exemplifies
quite common practices of companies to leverage economies of scale.

8.2 Methods for inventory management

There are methods for inventory management used in logistics according to the
characteristics of the operation. Each company or industry has a particular form of
using their resources and managing their inventory levels. Below are described the
main characteristics that companies commonly consider managing inventories, as
listed by Coyle (2018):

 Dependent vs. independent demand

The type of demand of a product respective to another article is a determinant

of the type of inventory requirements. A good may have dependent or
independent demand, according to their condition of dependency to another
product.

A product is said to have dependent demand when it is part of the assembly of

a larger product, for instance, an original windshield as part of a car
manufactured in the production plant. In this case the windshield
manufacturing company receives a schedule of the units it must produce to
cover the automobile production process set forth by the car production facility;
therefore, the windshield demand depends on the unit production schedule for
that specific automobile model.

A product with an independent

 demand is not subject to the production of another good, as there is a market
demand and the company makes their own efforts to obtain a portion of the
volume consumed by that market, competing with similar or substitute
products of other companies.

A replacement windshield has an independent demand, that is, the

manufacturing company dedicates to produce them for sale in the market, and
not for automobile assembly companies, therefore, it is considered an
independent product as it does not depend on the specific ongoing production
of that automobile model. The potential market for the product is the total
number of vehicles of that model in the market, which may need a replacement
for that piece at any moment.

The production of merchandise with dependent demand is not ruled by a

production forecast based on potential sales calculated by the same company,
unlike merchandise with independent demand, as they focus their production
on the requirement set forth by the manufacturer of the item they depend on
through a contract. That is, dependent demand goods are manufactured based
on forecasting by the company manufacturing the product they depend on.

 Push inventory control system vs Pull inventory control system

The push inventory system provides replenishment techniques in distribution

centers to anticipate demand. One of its main characteristics is it considers a
that company's output capacity determines its level of inventory, and sales must
be based on that volume. One of the priorities for the company is seeking
higher output efficiency to obtain economies of scale, without paying too much
attention to the amounts the consumer requires.

The push system may be very appropriate in situations where demand is higher
than supply, meaning that the higher the output, the higher the sales. With this
system, strategies to increase points of sale are established to cover a higher
geographic density with more product. It is mainly used when the market is
saturated and consumers have many purchase options, leading the company to
combine sourcing and marketing strategies to generate consumer preference
and brand loyalty.

The pull inventory control system works through orders placed by clients,

once the company determines the specific need of the client through
 negotiation, a purchase order or sales forecast based on historical volumes,
then it proceeds to produce that sales level. Its main characteristic is that it
seeks to maintain the lowest possible inventory level determined as the sales
capacity the company has for that product.

 System-wide vs. single facility solutions

This characteristic is determined by the type of sourcing the company must

perform respective to order centralization or individualization by warehouse. In
some situations, the companies centralize all requirements in a main
warehouse, which supplies their distribution centers as each area's individual
needs arise; this type of sourcing is denominated centralized or system
sourcing. The opposite occurs when each warehouse works independently,
executing their sourcing orders by themselves directly with the vendor, and this
is called decentralized sourcing.

In any case, inventory management in a company must be guided by the following

basic concepts:

Click on each item for detailed information

Reorder point
It is the established inventory level when you must place the following product order in
normal conditions. This level must consider the vendor’s lead time (manufacturing and
delivery) to avoid a situation where the company is out-of-stock.

Maximum inventory
Refers to the maximum level of inventory the company must maintain to avoid
obsolescence risks and high maintenance costs.

Minimum inventory
It refers to the critical level the company may allow itself to have, determining that it
must be placed in an urgent order, incurring additional costs if necessary to get the
product on time.
Average daily consumption
It is the average usage level to determine inventory levels.

Standard deviation
It is the peak of demand you may obtain relative to the average, based on historical
information.

Average replenishment cycle

It is the average time showing the separation between consecutive orders.

Lead time
t is the time elapsed since the order is placed until it is supplied.

Based on these concepts, Coyle (2013) highlights some methods used by companies to
manage inventories:

1. Fixed Order Quantity in certainty conditions: Involves ordering a fixed

amount of product every time an order is placed, this occurs once the reorder
point has been reached. The amount is established by the company based on
cost and demand characteristics, as well as relevant inventory maintenance and
reordering costs.

2. Fixed Order Quantity in uncertainty conditions: Involves ordering a fixed

quantity of product when the reorder point has been reached or when a surge
in demand is observed, or if the vendor delivery conditions change. This kind of
 situations are closer to reality because markets are generally an uncertain
environment.

3. Fixed order interval: Establishes a periodical reordering conducted in defined

regular times. For instance, placing an order once a month or every 15 days.

4. Just in time: Consists in maintaining a null or the lowest possible level of

inventory, strongly dependent on vendor product being delivered in the precise
moment when they are needed. This inventory management method is very
common in the automobile industry, where raw materials of components are
not stored, and the production line works in sync with the delivery of such
components by vendors.

Conclusion