Designing Distribution for Profit

Aug. 1, 2009
A food ingredient manufacturer gained tactical and strategic supply chain advantages after its 3PL invested millions to build a new facility and overhaul its operations.

Outsourcing logistics operations is hardly a new strategy. The practice dates back to ancient times when ships sailed the oceans collecting and consolidating merchandise for multiple buyers. Even then, consolidation warehouses were likely involved at origin and destination ports so goods could be staged for the first and final miles of the voyage.

Use of third-party logistics providers (3PLs) has grown over the last 75 years because the benefits are based on simple math. If a company buys an asset to store or move its own goods, that asset is only productive when it's moving the company's inventory. No activity means the asset is idle. Outsourcing to a third party allows the asset to be used again to store or move goods owned by other companies. This increased productivity means the asset has a lower cost per use, and that reduces operational costs for every company involved.

Third-party warehouses typically assess charges on a per-unit basis for monthly storage and again on a per-unit basis each time the pallet is handled. There are variations, but the general goal is to gain operational savings through shared use of assets.

However, several years ago, a fundamental change began to take shape. Manufacturers, distributors and retailers began to establish more specialized and strategic relationships with 3PLs. In the new era of outsourcing, capitalization is just as important as operational savings. Companies are replacing their own investments in brick-and-mortar assets and material handling systems with investments made by outsourcing partners. In other words, they are outsourcing capital requirements along with logistics. The result: Outsourced logistics is a strategic advantage rather than just a way to reduce costs.

A Case Study

Using outsourcing as a strategic advantage can be illustrated by the recent case of Sataria Distribution, a 3PL in Indianapolis.

Patrick O'Keefe, general manager at Sataria, is a seasoned big-box warehousing manager who has operated warehouses owned by many manufacturers and distributors over his career. “A good general manager can save his employer hundreds of thousands of dollars in space and labor expense every year by simply managing the warehouse with a focus on the tactical elements of space and labor utilization,” he says.

Applying those skills to a 3PL operation has allowed O'Keefe to achieve similar savings for users of warehousing operations.

“There is an additive, strategic advantage to outsourcing logistics functions that is not so apparent to those looking to simply save space and labor expense,” he explains. “Comparative savings represent low-hanging fruit. The real advantage of outsourcing today is defined in the user's ability to leverage investments of the outsourced logistics service provider as opposed to making those investments on its own. A customized logistics solution that incorporates real estate, rolling stock, information systems, management and personnel will generate much more than comparative savings. Our solutions incorporate capital savings.”

O'Keefe uses a recent example to show how it's done. Since 2001, Sataria has provided warehousing services to a major food ingredient manufacturer that had been using multiple facilities to serve a small geographic area.

“At the time, the manufacturer had five public warehouses spread around a 25-mile radius within Indianapolis,” O'Keefe says. “In addition, the manufacturer had proprietary warehousing at the manufacturing plant.”

The manufacturer believed this approach would reduce logistics costs, but that theory didn't work in practice. Public warehousing was used for overflow storage as a way to create a pay-as-you-go cost structure. But this strategy ironically increased the cost of inventory management. Without realizing it, the company was paying for fully burdened cost structures, just as it would if it was running its own warehouse operations. In public warehouses, empty slots, aisle space, docks and lost productivity are built into pay-as-you-go pallet rates.

Having five warehouses resulted in five distinct P&Ls, complete with fixed and variable costs. Each facility had managers, supervisors, customer-service employees and information systems rolled into the manufacturer's rates. So, the manufacturing customer had to manage redundant, fixed-cost items in each of the five warehouses as well as invest in safety stock and transportation.

Distribution Solution

The 3PL assembled a series of properties for a new, built-to-suit warehouse that would be located within three miles of the customer's manufacturing facility. Sataria built a 600,000-square foot, concrete, tilt-panel building customized to the manufacturer's safety, sanitation and security needs.

“It is very difficult to ensure stringent sanitation standards in a general-purpose building,” O'Keefe explains. “This is especially true of food ingredient distribution because dust can be an issue.” The 3PL's construction plan included boxed-beam construction, rapid air-replacement systems, humidity controllers, Lapidolith (dustproof) concrete finishes and dust- and air-filtration systems.

“We even went so far as considering food contamination as a potential terrorist threat,” recalls O'Keefe. “The building has one entrance protected by a security office. We have security cameras and keypad entry systems. All visitors are screened very carefully.”

Next, Sataria invested nearly $2 million in software and hardware to manage its customer's inventory. The technology ensured accuracy and timeliness and also increased productivity, resulting in lower handling costs.

“The base software package is a readily available product,” says Roger Delearney, Sataria's director of information technology. “It can be purchased and installed in any warehouse. However, we invested nearly double the base-software cost for modifications that would allow specific functions to be performed on behalf of our food ingredient customer. The system monitors workloads to ensure trucks are loaded and unloaded in a timely manner. It directs cycle counting as part of normal order picking. It allows task interleaving and other specific functionality in the warehouse. Our entire warehouse is paperless, and the system has intuitive capabilities that ensure we meet our operational goals.”

The system also plans the use of dock doors, manages dropped trailers in the yard and even schedules daily maintenance according to bay and location utilization. In addition, lift trucks are equipped with on-board computers and scanning hardware, allowing for real-time inventory management.

Other material handling equipment is also tailored to the manufacturer's requirements. “Our customer ships a lot of flexible intermediate bulk containers (FIBC), also known as super-sacks,” says O'Keefe. Although FIBCs are easily and inexpensively packed at the manufacturing facility and transported to the end user, they function poorly in the warehouse. Super-sacks overhang the pallets and cannot stack without racking support.

To solve this dilemma, Sataria installed a racking system from Twinlode Corp. featuring drive-in racking and invested in a lift truck capable of handling two 2,400-pound FIBCs at a time to heights of 24 feet. “We move 5,000 pounds at a time,” says O'Keefe. “Once we arrive at the designated location, we are able to slot 5,000 pounds of material in a single movement.”

Preventing product damage was another matter. Food ingredients often settle after packaging and can sometimes harden. To prevent this, Sataria purchased pallet inverters that allow an operator to flip a load of material over onto another pallet. Inverting unit loads helps prevent product damage from hardening and settling and also makes it possible to replace the original shipping pallet if it is broken during the handling process. Additionally, inverters allow an operator to remove a leaking bag of ingredients from the bottom of a unit load without restacking the entire pallet by hand.

“Sataria invested nearly $20 million dollars in the overall solution of the building,” reports John Jacobs, founder of Sataria. “Each of the components is relatively simple, but the integration afforded by the overall plan provides the highest degree of excellence and productivity. We have saved our customer lots of money and kept the investment off of its balance sheet. We listened to what our customer needed and then designed and built the solution as a third-party operator using our capital.”

Integrated Package

Once the project was complete, the manufacturer had access to an integrated package of real estate, information management systems, material handling equipment and rolling stock — all within three miles of its manufacturing plant.

“Sataria consolidated the five local public warehouses and the plant-based warehousing operation into a single facility,” O'Keefe says. Transportation savings — from shortening the length of the shuttle to the warehouse from the plant — he estimates as being hundreds of thousands of dollars lower every year.

The moves also had strategic benefits. “For example, our operation was able to significantly reduce safety stock required to support the local supply chain,” O'Keefe explains. “With one warehouse versus six, the operation consolidated all the inventory information onto one warehouse management system (WMS). Doing so improved line fill rates to nearly 100%. Orders were getting filled on time, more completely, more accurately and with fewer exceptions. As a result, customer service was greatly improved.”

Bob Moran is an operating partner with Creo Capital Partners, a private equity firm based in Pacific Palisades, Calif. He is a past member of the International Warehouse and Logistics Association board of directors, former president of the CSCMP Chicago Roundtable, a frequent speaker at industry association conferences and recipient of the 2009 IWLA Distinguished Service and Leadership Award.