Understanding the costs of warehousing
Tuesday, January 17, 2017
All companies with warehouses incur the same elements of cost, but they compile them differently. However, a costing system can be used to compare costs of one warehouse to another, or one company to others.
Some warehousing costs tend to be ignored or misallocated because the analyst does not recognize where they belong. In any costing system, allocation of overhead costs is a matter of judgment, and no specific formula will be correct for every user. The cost models shown here have been designed to ensure that no item is overlooked.
Each user should customize the models and make individual judgments regarding allocation of administrative costs.
4 categories of warehouse costs
1. Handling: All expenses associated with moving product in or out of the warehouse should be included in the handling cost center. The largest component is the labor used to handle the product that moves through the distribution center. It includes receiving, put-away, order selection and loading. It also may include labor to re-warehouse, repackage or refurbish damaged product.
Handling also includes all costs associated with the equipment used to handle product in the warehouse, such as the depreciation of equipment cost and the cost of fuel or electricity to power the equipment.
Other handling expenses are the detention of truck or rail cars, operating supplies and trash disposal. In effect, handling includes all those costs that are associated with "goods in motion."
2. Storage: Storage expenses are costs associated with "goods at rest." These costs would be incurred whether or not any product ever moved. Because storage expenses are related to the cost of occupying a facility, and these costs are normally accumulated each month, storage is expressed as a monthly cost.
If an entire building is dedicated to an operation, storage expenses are the total occupancy cost for that facility.
3. Operations administration: These expenses are incurred to support the operation of the distribution center. Closing the facility would eliminate these costs. Included are costs for line supervision, clerical effort, information technology, supplies, insurance and taxes.
4. General administrative expenses: Expenses not incurred for a specific distribution center are included in this category. General management, nonoperating staff and general office expenses are examples. Allocation of such expenses to each warehouse is a judgment call.
Most warehousing costs, particularly storage and handling, can be influenced by improvements in productivity.
Improved methods and equipment may enable the operator to increase the number of units moved without increasing labor, resulting in a higher number of units handled per hour. Changes in inventory, storage layout or equipment may enable the operator to expand the number of units stored in the same number of cubic feet of storage space.
The risk factor
Cost per unit is escalated when a distribution center is not fully utilized. Fixed costs always will be influenced by the rate of utilization.
Variable costs, such as labor, never are quite as flexible as they seem. Management may be reluctant to eliminate experienced workers, particularly when they will be needed for a coming busy season. The same is true for forklift trucks and other materials handling equipment. Therefore, the primary risk in controlling costs is the rate of utilization.
Errors represent another unknown risk. People make mistakes, which may result in product damage and errors, or shipping errors.
Just as the insurance underwriter factors in the risk of loss, the warehouse operator must make a realistic estimate of risk costs. Risk may be expressed as a percentage of total warehousing costs. It should be based on past experience. Methods to reduce risk should be explored.
The simplest way to calculate the risk factor is to include it in the size of the markup. Many time and material agreements have a low percentage of profit, but the unit pricing agreement must factor in a higher profit percentage that reflects the substantial risk of changing volume.
As you contemplate the risk factor, consider the position of the buyer. With a time and material agreement, the buyer agrees to pay for all space and labor that is used, which often includes the rent for a building that is dedicated for the buyer’s use. In contrast, the buyer of a unit price agreement pays only for services that actually are used. Expansion and construction can be challenging, as well as costly.
A good analogy is the difference between a hotel and an apartment. When you stay in a hotel, the price per square foot of space occupied is higher than the cost of leasing an apartment. You pay the premium because you want the flexibility of occupying the space only on the days you need it. While the apartment may be cheaper, you pay for it whether or not it is in use.
Developing a handling price
A building-block approach using the four categories of warehousing costs can be used to develop an hourly selling price. First, all of the costs listed in Section 1 (Handling) are totaled. Next, a portion of the costs in Section 3 (Operating Administrative Expense) and in Section 4 (General Administrative Expense) are added to direct handling expense, in order to develop a burdened handling expense.
An additional percentage of profit is added to develop a handling sales price. This figure is divided by the hours billed, to convert the figures into a handling fee per man-hour. While you may not invoice your customers by the hour, the hourly fees can be used to check the validity of current pricing.
Creating a storage price
A similar building-block approach is used, but the result is expressed in square feet, rather than hours. Since storage costs increase with time, this storage fee is expressed on a per month basis.
The first step is to total all costs listed in Section 2 (Storage). Following the handling example described in this article, a portion of operating and general administrative expenses must be added, in order to develop a burdened storage expense. Then, a desired profit margin percentage is added to create a price per square foot per month. That price determines the storage rate per unit.
The importance of inventory turns
Because storage costs are calculated on a monthly basis, the total cost of storing an item depends on how long it will be in the warehouse.
In the past, each unit received for storage had an anniversary date with renewal storage charges added each month afterward. Later billing systems were designed to simplify the clerical task by charging a half month for items received after the 15th of the month, and a full month for everything in storage on the first day of the succeeding month.
Regardless of the system used, an inventory that turns 24 times per year should cost less to store than one that turns six times per year. For that reason, the inventory turn rate is a critical data point in creating storage prices.
The "make or buy" factor
Nearly all services available from a logistics service provider can be replicated by an internally managed project. The buyer who knows the amount of space needed, and has estimated the number of people required to staff the operation, should be able to simulate the "do-it-yourself" cost of providing comparable logistics services.
This cost is then compared with the prices offered by a logistics service provider. In this situation, the risk factor is critical. The do-it-yourself option is full of risk, unlike a unit price agreement that provides maximum flexibility because the risk is absorbed by the logistics service contractor.
Simulating a logistics service provider
Some private warehouse operators treat their operations as if they were public warehouses. Transfer costs for internal storage and handling prices are determined, and the warehiouse manager is held accountable for profitable operation at the established rates.
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