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Quantitative Data: Why Have Warehouses?

In this book, a warehouse represents a facility where firms store product or a location where product simply passes through from one vehicle to another. It can be called a distribution center, a mixing center, a cross dock, a plant-attached warehouse, a forward warehouse, a hub or central warehouse, a spoke or regional warehouse, or a host of other terms.

To understand how to optimally locate warehouses, it is important to discuss why warehouses exist. Wouldn’t it be much cheaper for companies to load the product only once, at the manufacturing location, and ship it directly to the customer? Stopping at a warehouse adds loading, unloading, and storage costs, not to mention the cost for two legs to transportation (one leg from the plant to the warehouse and one leg from the warehouse to the customer). In cases where you can ship directly from the plant, it is usually good to do so. Therefore, it is important to ask questions to see whether you can avoid warehouses altogether. But in most cases warehouses are needed in a supply chain for the following reasons:

  • Consolidation of Products—Often, you will need to deliver a mix of different products to your customers and these products may come from various sources. A warehouse serves the useful function of bringing these products together so that you can then make a single shipment to a customer. This will be cheaper than having the products ship to the customers directly from each individual source of supply.
  • Buffer Lead Time—In many cases, you will need to ship to your customers with lead time that is shorter than that which can be offered by shipping directly from the plant or supplier location. For example, you may promise to ship products to your customers the next day but your plants or suppliers may have a lead time of several weeks before they are able to make the product available to the customer. In this case, the warehouse holds product at a location closer to the customers in order to provide the next day transport promised each time an order is placed.
  • Service Levels—Where you store the product and its proximity to the market where it will be consumed is also a measure of the service level the company can provide. The need to be close to customers can create the need for multiple warehouses. Overall cost versus service level is one of the most classic trade-offs in supply chain network design.
  • Production Lot Sizes—Setting up and starting the production of a single product or group of similar products on a line can have a significant fixed cost associated with it. Therefore, production plans attempt to maximize the number of units of product made during each run. (This production amount is called a lot size.) Understandably, these lot sizes normally do not match the exact demand from the market at the time. This requires the extra units to be “stored” in warehouses until future demand requires them. Production lot sizes versus inventory storage costs is also a common supply chain design trade-off.
  • Inventory Pre-Build—Some industries see huge spikes in the supply of raw materials (seasonal food harvests) or in the demand of finished goods (holiday retail shopping). In the case of raw material supply spikes, some firms must store these abundant raw materials until the time they will be needed for steady monthly production cycles. Other firms must immediately use these raw materials to produce finished goods that are not yet demanded. These additional finished goods must then be stored until demand in future time periods requires them. In the case of demand spikes, companies find themselves with insufficient production capacity to fulfill all orders during peak periods of demand. As a result, they must use their additional capacity during off-peak time periods to make finished-good units to be stored awaiting their use to fulfill the upcoming spikes in demand. The use of costly overtime production versus inventory storage costs is another common supply chain design trade-off.
  • Transportation Mode Trade-offs—Having warehouses often allows you to take advantage of economies of scale in transportation. A warehouse can help reduce costs by allowing the shipment of products a long distance with an efficient (and lower cost) mode of transportation and then facilitating the changeover to a less efficient (and usually more expensive) mode of transportation for a shorter trip to the final destination (as opposed to shipping the entire distance on the less efficient mode).

It is also important to match up the preceding list of reasons for warehouses with the types of warehouses in the supply chain. A supply chain may have many types of warehouses to meet many different needs. Here are some common types of warehouses:

  • Distribution Center—Typically refers to a warehouse where product is stored and from which customer orders are fulfilled. This is the most common and traditional definition of a warehouse. When a customer places an order, the distribution center will pick the items from their inventory and ship them to the customers. These types of facilities are also called mixing centers because they “mix” products from many locations so that your customers can place and receive an order from a single location. If a manufacturing company does not have this type of warehouse in the supply chain, customers may have to place several orders or receive several shipments from different locations depending on where each product they want is made.
  • Cross-Dock—Usually refers to a warehouse that is simply a meeting place for products to move from inbound trucks to outbound trucks. The term simply means that products pass (or cross) from one loading dock (for inbound trucks) to another loading dock (for the outbound trucks). For example, in the case of a produce retailer with 50 stores, they may have a full truck of fresh peaches arriving at the inbound docks from a single supplier. The peaches are then removed from the truck and some are placed in each of the 50 waiting trucks on the outbound side, according to the relevant store demand. This happens for peaches as well as a host of other produce items. Basically full trucks arrive from a single supplier on the inbound side of the facility, and then transferred to multiple trucks on the outbound side of the facility resulting in fully loaded truckloads with a mix of product from each of the suppliers quickly sent on their way. The best-run cross-dock systems have all the inbound trucks arriving at approximately the same time so that product stays at the cross-dock for only a short period of time.
  • Plant-Attached Warehouse—Refers to a warehouse that is attached to a manufacturing plant. Almost all plants have some sort of product storage as part of their operations. For some, it may simply be a small space at the end of the line where product is staged prior to being loaded onto a truck for shipment. In other cases, the warehouse can act as a storage point for product made at the plant or for products made at other plants. In this case, this warehouse acts like a distribution center co-located with the manufacturing facility. A major benefit of a plant-attached warehouse is the reduction of transportation costs because a product does not have to be shipped to another location immediately after it comes off the end of the line. When you have plant-attached warehouses, sometimes the standalone warehouses are called forward warehouses, meaning they are placed “forward” or out closer to customers.
  • Hub Warehouse or Central Warehouse—Refers to a warehouse that consolidates products to be shipped to other warehouses in the system before moving on to customers. Different from cross-docks, the products are normally stored in these locations for longer periods of time before being used to fulfill demand. The other warehouses in the network are then typically called spokes or regional warehouses.

In practice, you will find many different names for warehouses. These names are most likely just different terms for what is described in the preceding list. In addition to the types of facilities, there are also needs for different temperature classes (frozen, refrigerated, or ambient), different levels of safety (hazardous or nonhazardous), and different levels of ownership (company owned, company leased, or the company uses a third-party facility).

As an interesting side note and to further illustrate the wide range of warehouse types we have experienced, we have even seen caves used as warehouses. Caves have the nice advantage of maintaining the same (relatively low) temperature and have prebuilt roofs. If you can get trucks into and out of them and have room to store products, caves also make great warehouses. Kansas City is probably the best-known location with cave warehouses.

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