The Role of The Warehouse in eCommerce and eRetailing: Trade-off and Benefits

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Efficiently optimizing inventory, storage space, labor, costs, and time in eCommerce (e-retailing) is required to attain customer satisfaction and economic profit.  For the Operations Researcher, this is no easy task; for the in-the-dirt manager with competing priorities and pressures from her chain-of-command, it is even a bigger challenge.

Most people are familiar with the front-end of eCommerce — the store, search, navigation, the cart, and payment.  But, what most consumers don’t realize is that the true magic and the more technically challenging piece of eCommerce is actually what happens after “click” — The Fulfillment, which often requires a Warehouse.

In what follows, I’ll discuss the role of a Warehouse and how the Warehouse meets the current needs of eCommerce.

Background

After a customer orders online, the order is virtually assigned to a fulfillment center (FC), the item(s) at that fulfillment center decrement in quantity and then Age (wait to be picked).  An FC is several thousand feet in size and typically consists of a Picking Area and a Reserve Area, where items are stored in bulk on pallets and the items are used to Replenish the exhausted items in the Picking Area.

The “splitting” of a Warehouse like I have described is technically called “Multi-Echelon, Two-Stage Serial Systems” in Operations.

From a General Manager’s perspective, the Profit Tree below is a good reminder of what we’re all trying to achieve:

The Role of a Warehouse

It takes labor, capital, space, equipment, and complicated information systems to have a Warehouse.  Unfortunately, most firms cannot avoid this expense all-together; reduce, yes, but the Warehouse plays a really important role in the supply chain.  Namely, The Warehouse is a strategic response to Supply & Demand, Transportation Costs, and Value-Added Processing.

Supply & Demand

A major challenge in managing supply chains is that demand can change very quickly, but supply is takes longer to change — that is, supply is not as responsive because there is usually some transformation that needs to happen, such as raw materials to finished goods, which takes time. But, demand is not very forgiving or patient and can change almost instantly. Supply is more “sticky”.

As a response to unknown or seasonal demand, the Warehouse plays a strategic role in assuring that there is product available, so that customers don’t find themselves wanting and firm doesn’t find itself unable to meet demand and face loss of sales, goodwill, and morale for the employees.

The Warehouse allows the firm to respond quicker when demand changes. The Warehouse acts as a buffer to changing demand, unreliable transportation, congestion in any part of the supply chain. As an added part of the complexity of supply chain management, the points of congestion in the system must also be managed.

Some questions to consider:

1. Given the approximate location of 80% of the customers and considering costs, response time, political climate of the country, and transportation reliability, what is the ideal geographical location of material sourcing, manufacturing, assembly, and warehousing?
2. What inventory buffer stock levels are appropriate for The Warehouse to hold?  Replenishment levels?  Use-to-Exhaust policies?

Consolidated Product Reduces Transportation Costs

There is a fixed cost every time product is transported.  Given the price of fuel currently and the instability of the US Dollar to other currencies, this is especially true. To amortize or reduce the pain of this fixed cost, it’s necessary to fill the carrier to capacity. In the industry, this is typically called “Full-Truck-Load” and the opposite is “Less-Than-Truckload (LTL)”, regardless if transportation is achieved by truck, plane, or boat.

Provide Value-Added Processing

The final assembly could be done at The Warehouse.  For example, if you produce a product that is private-labeled for your customer, then the product differentiation could be done at The Warehouse.  Generic parts can be shipped to The Warehouse and then labeled to the customer specifications to achieve differentiation.

Inventory Holding Costs

It must be noted that holding inventory has some explicit and implicit costs associated with it.  Some explicit costs are the following:

1. inventory investment
2. insurance
3. taxes
4. damage
5. theft
6. relocation costs
7. labor

As a picture, the Inventory Holding Costs Tree might look like the following:

Notice that the costs above are within-warehouse costs.  There is also substantial opportunity on reducing Transportation and Packaging costs into the Warehouse and out-of the Warehouse.  The clear implicit costs associated with inventory are the defects and hidden factories that inventory tends to hide.

Summary

To meet the needs of customers in an eCommerce environment requires the use of a Warehouse.  There are clear trade-off’s: a Warehouse is costly and challenging to manage, but the upside is having the ability to meet the high levels of customer expectations in eCommerce¹.

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