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cost benefit analysis

When to Invest in a New Warehouse?

Should we invest in a new warehouse when the current one no longer has sufficient capacity?

Recently, there was a project about the warehouse capacity and justification of leasing another warehouse for organic growth and potential new business.

Current situation

We have a warehouse that is utilizing more than 90% of the pallet location capacity (rule of thumb is 80% for an ideal situation). To cater for annual organic growth of the current business as well as to anticipate potential new businesses, there is a requirement from operations to expand to a new warehouse.

Expansion can be in the form of operating from the current warehouse and a new one, or shifting the entire operations to a totally brand new big warehouse.

I understand from the operations' s point of view, this is the natural course of action to take.

Factors to consider before embarking on searching for a new warehouse

  1. Have we consider maximizing the space usage for the current warehouse? Is there ways where we can rearrange items (pallets or processes) to free up more space?
  2. Do we have excess pallets from the customers that are stored in the warehouse? Sometimes, customers tend to store a high level of buffer stock in the warehouse without realizing.
  3. Do we have dead stocks that have not been ordered for a long time?

There are definitely more ideas to maximize the usage of the warehouse space. However, potentially, there is only that much the operations can do to squeeze out more storage locations.

Cost Benefit Analysis

From the financial point of view, there are a couple of elements we need to look into as well.

  1. Are the annual organic growth forecast realistic? Do we see a similar trend from the historical data?
  2. How confident are we of getting the new businesses? What are the space requirements and when will they be coming into the warehouse?
  3. Do we know the price we are charging the new businesses in terms of price per pallet location?
  4. We are required as well to perform 2 tasks for due diligence.
    1. Calculate the current cost incurred per pallet location. Example, we take the total pallet locations capacity divided by the total operating cost (OPEX) to run a warehouse.
    2. Calculate the cost incurred if we are to get a new warehouse. This includes capital expenditure (CAPEX) for pallet rackings, MHE and automations. Operating cost will be manpower, utilities etc.

Financial analysis on current warehouse

  1. If we are charging our current customers lesser than the cost incurred per pallet location, this implies we are making a loss for each storage location. If we charge the excess pallet lesser than the cost of the storage location, we should start looking at moderating the rates.
    • There will always be the issues of re-negotiating with the customers whenever it comes to rates. However, the operations should not be making a business loss.
  2. If we are indeed getting a new warehouse, we need to deduce whether the new business or current business is able to have a profit margin that is higher than the cost incurred.

Ways to get more storage space

There are various ways to get more space for warehousing.

Leasing a new warehouse

  • This is the easiest way in terms of operations. The benefit is that we can design the warehouse to our own requirement. However, the issue is with the first few years of operations where space will be underutilized. In order to allow growth of the business, we need to have space. Yet, before managing to clinch any new customers, the operations is literally sitting on empty spaces, burning cash.

Getting a flexible space requirement from 3PL (Third Party Logistics) company

  • This is another method. The pro is the flexibility of getting and paying only for the required space. There is no space wastage. Only when we are able to build up a base volume, then we search for an ideal warehouse of suitable size. The con is that because this is operating not from our own facility, we need to pay extra in terms of volume handling, storage fee etc. The standard might not be as good as what we like.

If we decide to operate from multiple warehouses, there is also the intra-warehouse transfer that has to be considered. What is the cost like for the transportation? How are the signal to request transfer of volume be designed? This will spin off into another area which we need to factor in.

Striking a Balance

On one side, we have the business development side who has the objective to getting more business for the company. This will impact the top line of the financials.

On the other side, we have the operations side who has to run the operations at a cost efficient manner. This will impact the bottom line of the financials.

As a P&L (profit and loss) owner, we have to ensure our business is profitable. We need to expand our business, and this is where the importance of new clients lie. However, we also need to make sure that we are keeping an eye on our operating cost. Otherwise, the profit margin will gradually be eroded. Thus, the need to operate from the most cost effective method.




This Post Has 2 Comments

  1. Great blog about when to invest in a warehouse provided me great information the methods you provided to analyse the cost benefit was very helpful thanks for such a great blog.

    1. Glad you find the information useful. I have learned this from the experienced colleagues who are in the warehousing industry.

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