Cost Justification of a Warehouse Management System: A ...

WHITE PAPER

Cost Justification of a Warehouse Management System: A Five Step Plan

Introduction

Executive Summary

Warehouse management systems (WMS) have become essential to the smooth and efficient operation of complex warehousing and distribution environments around the world. Advances in computing, radio frequency and software technology --as well as cost reductions in some of these areas--enable facilities of all sizes to enjoy the benefits of sophisticated warehouse management systems. Much of this advanced functionality was previously affordable only to larger warehouses and distribution centers. A key aspect in the evaluation of a WMS for any implementation, large or small, lies in understanding its components and benefits, and in justifying the investment of time and money.

Recognizing the need for a WMS is a straightforward exercise for many warehouse managers. Inaccurate inventories and pressures to continually reduce costs make the investment decision almost intuitive. Investments, however, are rarely made based on intuition. Fortunately, the benefits of a WMS can be identified and, to a great extent, quantified, in order to provide an accurate basis for justification.

The Five Step Plan

Step 1: Define the Problem Areas Four principal benefits can be expected to arise from the implementation of a WMS. These benefits lie in the four areas that cause the majority of efficiency problems in warehouses, including:

1. Inventory Accuracy

2. Resource Management

3. Customer Service

4. Visibility

With these in mind, the process of justifying a WMS begins to take shape. The first step is to identify the main problems currently experienced. Begin by creating a matrix using these four benefits as the primary categories. Next, list the facility's problems under each category. Usually, the person responsible for managing the warehouse will be best placed to come up with a definitive list of challenges. However, to ensure that all problems have been identified, other stakeholders of the warehousing process should be asked for their input. Openended questions about problems and solutions are often the most useful: "What is your biggest time killer in picking an order?" or "what do our customers (internal and external) think about our current level of service?" Common problems occurring under the heading of inventory accuracy may include excess inventory, lost product, and mis-picks. Under resource management, problems may include wasting time looking for material, inefficient pick paths, and no means of measuring performance. Customer service problems often include ship errors and delayed shipments. Finally, information management problems may include stock-outs, false stock-outs, transaction update delays of hours and days, and data entry errors.

A Five Step Plan

Step 2: Estimate the Costs

Once warehousing problems have been documented, the next step is to estimate the costs associated with each. This step is critical to understanding the severity of any problems. A variety of equations and industry standards can be used to quickly estimate the costs. Four examples of typical costs are listed in Table 1. Having completed a quick estimate of the costs, it becomes easy to identify the most urgent problems-- those problems that represent your biggest cost factors. The first example indicates the impact of shipment errors. Two calculations are made: one assuming a shipment accuracy of 98.5% and one assuming 96%. Shipment accuracy above 95% is often thought of as excellent, yet the cost of errors in these two cases is significant--$33,750 and $90,000 respectively.

These costs must be broken out in detail, providing critical evidence to obtain budget approval for the WMS.

Step 3: Estimate the Savings

After identifying the major problems within the warehouse and calculating their cost to the company, the next step is to put some realistic estimates on how much money a properly integrated WMS will save. At this stage, it is tempting to overestimate the money a WMS will save, and to underestimate the time frame in which it will do so. One way to safeguard against overestimation is to calculate two to three levels of potential cost savings -- conservative, moderate, and liberal. The most appropriate level of savings depends on current operational efficiencies. With current inventory accuracy of 85%, moderate to liberal savings could be expected in many areas. If inventory is already 99.9% accurate, the savings estimates should probably be conservative to moderate. Table 2 shows just eight common areas of potential cost savings. The ranges of savings are based on broad industry approximations.

Table 1 - Cost of Errors

Ship Errors

Shrinkage Data Entry Errors Lost Product

Occurrence

1.5% 4.0% (assume 50k orders/yr.)

1.0%

4.0% (assume 100k trans./year)

5.0% 7.0% (assume 50k orders x 5 lines/order)

Cost/Occurrence

$45 $45

.01 x $1M in inv. .01 x $7M in inv.

$10

$2.50 (10 minutes searching x $15/hour)

Total Cost

$33,750 $90,000

$10,000 $70,000 $40,000

$31,250 $43,750

A Five Step Plan

Table 2 - Potential Cost Savings

Potential Cost Savings

Labor Utilization Inventory Reduction Floor Space Utilization Maintenance Shrinkage Rolling Stock Increase Shipping Accuracy to Increase Data Entry Accuracy to

10-35% 5-30% 10-30% 0-10% 50-75% 10-20% 99% + 99% +

Let's look at specific cost savings examples. Labor utilization can be measured in a number of different ways. One common measurement is the cost of warehouse labor as a percentage of revenue. Prior to the installation of a WMS, one JDA customer spent close to 3% of revenue on warehouse labor. A year after implementation of their WMS, labor costs had fallen nearly a full percent (a savings of approximately $450,000), while their sales had increased by close to 30%. The WMS allows more to be done with fewer resources.

The wish to improve inventory accuracy is another prime reason to invest in a WMS. Inventory reduction and just-intime requirements have forced manufacturers and distributors to re-think traditional inventory management philosophies. Accuracy levels exceeding 99% are generally required to achieve world-class service levels, and this must be achieved within a competitive cost structure. Unless inventory accuracy is above 99%, it is extremely difficult to reduce stock levels with any degree of confidence.

The savings associated with the reduction of inventory levels may themselves justify investment in a WMS. Many companies have reported reducing inventory levels by as much as 30%. This level of reduction greatly affects carrying costs, which typically equate to 25% to 35% of the cost of inventory.

Consider the following simple scenario:

Picture a warehouse as an inventory pipeline. A company that turns $10 million of inventory 20 times a year has an annual inventory flow of $200 million or a daily flow of approximately $500,000. Assume that, through the use of a good WMS, inventory accuracy is near perfect and order cycle times have improved. With these improvements, assume that two days of inventory can be removed from the pipeline. The company realizes a one-time $1.0 million inventory reduction. The annual savings (from the reduction in carrying costs, which are at 35%) is $350,000.

Realistically, during the few months of implementation, cost savings will not be maximized due to "learning curve" issues such as training and a reengineered warehouse culture. However, over time, users should expect near perfection in those areas that were once major problems. Estimated cost savings should take into consideration the fact that year two will return greater savings than year one. Time plays a major role in the justification of a WMS. The objective should be to plan for the learning curve and minimize it. It is also important to identify a realistic implementation schedule, weighing the risks of a shorter schedule against the opportunity costs of a lengthier one.

Minimizing the learning curve can be accomplished through training (commencing long before implementation) combined with good internal communication (change management). One great way to ensure the implementation schedule remains realistic is to decide up front on the deliverables and schedule milestones. The scope of work should not be allowed to grow without a good reason--the sooner the system is up and running, the sooner the company starts saving money and realizing a return on its investment. Time can be saved, and risk minimized, by selecting a flexible and proven WMS product, rather than paying for extensive modifications on a baseline system.

A Five Step Plan

Step 4: Determine the Cost of a WMS

At this point in the process, it will be reasonably clear how much money and time a good WMS product will be able to save. The next step is to determine how much will have to be spent to integrate the system. Although vendors use various pricing models, the components of their pricing proposals usually fall into five categories.

These are license fees, custom development (if applicable), computer hardware, radio frequency hardware, and services such as design, implementation, training, testing and travel. Your internal costs to implement the system should also be included when defining the total cost of the implementation, as well as the cost of maintenance over the time period for which you are calculating the ROI.

An alternate pricing and implementation model may also be considered. WMS systems are now available on a Software as a Service (SaaS) basis. In this model you typically pay a modest up front implementation fee and then have a single monthly payment (including system and hardware costs and maintenance fees) for a specified period such as 3 or 5 years. Add the sum of the payments for the life of the contract and the implementation fee to determine total system costs.

Although the price of a solution is important, there are other important criteria that should be considered when selecting a vendor including track record, size, and the level of trust and confidence between vendor and customer.

Step 5: Calculate the Return on Investment

A number of financial tools are commonly used to justify capital expenditures. These vary in complexity from a simple break-even calculation to a comprehensive computation of net present value (NPV). Naturally, the more comprehensive the calculation, the stronger the case that can be made in requesting funding.

The NPV calculation compares the price of the WMS to the level of future savings that it will provide. One simple example of an NPV consideration is to consider whether you would rather have $100 today or $120 a year from today. NPV considers the time value of money. To arrive at an answer in this example, you would have to decide how much interest could be earned in a year on the $100. If you could earn more than 20% you would accept the $100 today because your earnings after one year would be greater than the $120 you would otherwise receive.

To calculate the NPV on an investment in a WMS, several pieces of information are needed. First, determine the total cost of the system. Second, calculate the annual savings for at least the first four years after implementation. Finally, determine the rate of return required by the company on capital investments. Let's look at an example.

Assume you spend $300,000 today for a WMS that will provide estimated savings of $100,000 in the first year and $150,000 in years two to four. Remember, these are the savings you calculated in step 3. Also remember, that the present day value of these savings is less that $100,000 and $150,000 respectively. Your objective in calculating the NPV is to determine the value of those annual savings today and compare it to present day's cost ($300,000).

Assume your management requires a return of 15% on all capital investments. At 15%, the first year's savings of $100,000 is worth $86,960 present day. Present day value $150,000 savings for years two through four is $113,415, $98,625, and 85,770, respectively. Add the total savings in today's dollars and you get $384,770. Because the total saving in today's dollars ($384,770) is greater than the total price of the WMS ($300,000), the investment can be justified.

A Five Step Plan

Summary

The Bottom Line

Competitive pressures are driving warehouse operations of all sizes to improve inventory accuracy, resource management, customer service and information management. Advances in technology and WMS products have driven the price of systems down. By following a sound, methodical approach, even smallto medium-sized operations can justify the investment required to keep pace with their competition.

About JDA Software Group, Inc.

JDA? Software Group, Inc., The Supply Chain Company?, offers the broadest portfolio of supply chain, retail merchandising, store operations and all-channel commerce solutions to help companies manage the flow of goods from raw materials to finished products and into the hands of consumers. JDA's deep industry expertise and innovative cloud platform help companies optimize inventory, labor and customer service levels. As a result, JDA solutions have become the standard for the world's leading retailers, manufacturers and distributors.

WEB

EMAIL info@

AMERICAS

US +1 800 479 7382 Canada & Latin America +1 480 308 3555

EUROPE

UK & Northern Europe +44 (0) 1344 354500 France & Southern Europe +33 (0)1 56 79 27 00

Singapore +65 6305 4350

Australia +61 3 9860 1000

ASIA PACIFIC

Japan

South Korea

+81 3 4461 1000 4-Col+or82 2 3016 0700

China

India

+86 21 2327 9400 +91 22 6700 0794

Copyright ? 2013, JDA Software Group, Inc. All rights reserved. JDA is a Registered Trademark of JDA Software Group, Inc. All other company and product names may be Trademarks, Registered Trademarks or Service Marks of the companies with which they are associated. JDA reserves the right at any time and without notice to change these materials or any of the functions, features or specifications of any of the software described herein. JDA shall have no warranty obligation with respect to these materials or the software described herein, except as approved in JDA's Software License Agreement with an authorized licensee.

06.14.13

 ................
................

In order to avoid copyright disputes, this page is only a partial summary.

Google Online Preview   Download