Strengthening your supply chain one link at a time.
We are thankfully a few years past 2020 and height of COVID. These were not just the days of masks and lockdowns, it was when shipping ports were jammed and millions of people first learned of the concept of supply chain. Is it possible that we could see jammed shipping ports and runaway warehouse rental rates again in the future? What if I told you it is possible without any increase in consumer demand? What if the fact that consumers want products faster can lead to a substantial increase in on-hand inventory?
I have given numerous speeches over the years about trends in supply chain, particularly in the third-party warehousing space. One concept I always include in my discussion is the notion of the Square Root Rule. Let’s say you have a single distribution center (DC) in your network today and determine there is a need for a second. Does this mean you will need to hold twice the safety stock in the 2-DC scenario as in the 1-DC current state? A good rule of thumb is that you will actually need about the square root of double the safety stock if you are stocking all SKUs in all your facilities. The square root of two is approximately 1.41, therefore around 41% more safety stock in your new network. If the next iteration is moving from a 2-DC network to a 3-DC network, then the increase is √ or 22%.
The most common reason why companies need to expand their warehouse network is the need to be closer to their customers. Generally speaking, the closer the DC to the customer, the quicker the customer can receive their products. Let’s say you have a network that serves 95% of the U.S. population within 500 miles of a distribution center. Since this is about the maximum distance for a single driver to haul in a day, let’s assume you can serve all your customers within 500 miles by the next day. A simple network analysis reveals this service level might require eight (8) DCs to allow you to be within 500 miles of the northern tip of Maine, to Key West, up to Peugeot Sound, and down to San Diego. As customer needs change, you discover that next day delivery is too long and same day service is now the norm. That same 95% of population service within 250 miles might require 21 distribution centers. According to the Square Root Rule, this company needs √ or 62% more safety stock.
These numbers should make every commercial real estate company with a warehouse portfolio jump for joy!! It is common knowledge that Amazon continues to push the boundaries of what is possible in terms of faster customer delivery. I urge you to use the Square Root Rule to do your own calculations on what happens with inventory needs, and ultimately the needs for warehouse space to position this inventory, as customer expect the delivery of their orders faster than ever.
Of course there are myriad factors that influence economic conditions (I didn’t even mention tariffs). I do believe there is a direct correlation between service levels and inventory on-hand. Be aware as we reach a new age of wanting our goods “now”.
—Brian Fish, St. Onge Company
