Strengthening your supply chain one link at a time. 

How Do Additional DCs Impact Inventory Levels

The triggering decision to initiate a supply chain network analysis may be the presence of one or more conditions within your network:  1) storage or throughput capacity has been exceeded.  2)  desire to reduce the cost to serve.  3)  desire to improve customer service via reduction in transit time.  4)  or significant time has passed since the last analysis, and executives would like to confirm that the current network is ideal or identify changes to react to evolving customer demands.

A common recommendation of a network analysis is the addition of one or more DCs.  As DCs are added, inventory turns will decrease resulting in need for incremental storage space and increased inventory carrying cost.  Adding distribution centers can increase inventory levels for several reasons:

1. Safety Stock Requirements: Each additional DC requires its own safety stock to account for uncertainties in demand and supply. With more locations, the total safety stock across the network grows, as each location needs a buffer to meet local demand. This requirement can be somewhat mitigated with improved demand forecasting.  If period demand for each item was known with 100% accuracy and suppliers were 100% on-time and in-full replenishment, then there would be no need for safety stock.  However, this is typically far from the case!
2. Increased Inventory Duplication: Different DCs may need to stock the same products to ensure availability in their specific regions. This can lead to inventory duplication across locations, even if overall demand remains unchanged. This especially impacts slow-moving items that may stock a minimum quantity of inventory.  As a side note, this may also result in reduced storage density within the DC due to a larger number of partial pallets/bins.
3. Longer Lead Times Across the Network: As demand is split across additional DCs, the replenishment frequency from suppliers to DCs may increase due to minimum order quantity constraints or the need to maintain efficient modes of transportation (i.e. full-truckload or rail-car quantities). Longer lead times will result in the need for additional cycle stock to meet customer service goals.  Cycle stock is the portion of inventory needed to meet demand between replenishment cycles.
4. Reduced Inventory Pooling Benefits: In a single DC setup, demand variability can be smoothed out by pooling inventory in one place. But with multiple DCs, each location manages its own demand variability, which can result in higher safety stock requirements.
5. Demand Forecasting Challenges: Forecasting becomes more complex with multiple DCs, as each location may experience different demand patterns. To avoid stockouts, businesses may hold more inventory to compensate for inaccuracies in regional demand forecasts.

Knowing the reason for incremental inventory does not imply that it is trivial to quantify how much additional inventory is needed.  The mathematical formulas used to quantify inventory levels are quite complex, and in my opinion extremely theoretical.  Inventory levels for each sku/location can be calculated if all variables can be measured.  However, there are many interdependencies across sku’s, and variables that cannot be accurately measured.  (i.e. demand variability, forecast accuracy, and supplier lead time variability, etc)

So even if adding DCs improves service levels, reduces delivery times for some customers, and reduces cost, it will undoubtably drive up total inventory.  This cannot be overlooked when evaluating if additional DCs are appropriate for the network.  There are methods to partially mitigate incremental inventory.  These will be explored in a future blog.
 
—Dave Wheeler, St. Onge Company
 
 

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