When dealing with inventory, many companies mistakenly believe that
centralization will cost them more in the long run. They can't imagine that
maintaining their inventory in a variety of warehouses instead of just one would
really save them money in the long run. But those businesses might be well
served to do a few minor mathematical calculations.
The formula is known
as the Square Root Law of Inventory. This formula has been around for five
decades and was proven to be a mathematical actuality way back in the 1970's by
business expert D. H. Maister. Essentially, the Square Root Law of Inventory
states that the number of warehouses a company has will cause a specific
increase in certain costs. Likewise, the less warehouses the businesses uses
will result in a specific increase in savings. This increase, either in a
positive or negative direction, can be mathematically computed using the Square
Root Law.
For example, if Company A uses 15 different warehouses for
their inventory then their costs would be likely be almost 75 percent greater
than if they only used a single warehouse. Also, if Company B originally had 5
warehouses and decided to centralize their inventory, they would see a savings
of just over 50 percent.
Of course, savvy organizations don't need a
mathematical formula to recognize the savings of having a single warehouse. The
costs of paying taxes on or of renting the facility are extensive on their own,
but those costs must also be added to the expenses of maintaining those
buildings, paying for warehouse staff, adding security features, etc. Basically,
all of the costs of having one warehouse double when a company adds another
warehouse.
Besides costs, multiple warehouses are also more difficult to
manage. Keeping track of the inventory at several locations, watching stock
amounts, handling orders, and planning distribution are all more complicated
when a company has to deal with more than one or two warehouses. Not to mention
that it can also complicate the addition of technology, such as supply chain
management software or ERP systems.
Switching to a more centralized
warehouse system may not seem possible to many businesses, but the change is
possible, especially in companies that already have effective supply chain
management in place. With modern supply chains, vendors are able to monitor
inventory and to replenish the stock on an as needed basis. As a result,
companies no longer have to fill warehouses with stock just to make sure they
have what they need for the future. Likewise, collaboration with logistics
vendors can help keep finished products moving so few need to accumulate in the
warehouse. The combination of savings from the efficient supply chain and the
centralized warehouse are significant.
However, companies can also make
some other changes with their warehouses to also save money. One of the most
common methods involves the Slow Moving Goods (SMG) strategy. According to this
strategy, a company can boost productivity by achieving a better balance in
their warehouse between SMGs and Fast Moving Goods (FMG). A division of 80% FMGs
and 20% SMGs is ideal for warehouse arrangements and prevents overcrowding in
the warehouse since the majority of goods being stored there will be almost
constantly on the move.
Before making a decision on the appropriate
strategy, businesses must also take in mind factors other than the Square Root
Law of Inventory. Transportation costs, for example, must be considered, as well
as lead time, availability, and warehouse proximity. In some cases, businesses
may opt to centralize their network by reducing their number of warehouses to
only two strategically located facilities. However, those types of decisions
should only be made when all of the factors have been weighed and given thorough
consideration.
While the convenience of having multiple warehouses may
seem worth the extra cost, the reality is that those warehouses are not only
more expensive but more difficult to manage and maintain effectively.
Centralizing inventory is the ideal solution for most businesses. |
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