Some concerning news crossed our Supply Chain Matters news desk that compelled a blog commentary. That news is that warehouse space acquisition across the United States has reached its highest level in over 16 years.

This data comes from CBRE, one of the largest global commercial real estate services and investment firms. CBRE reports that almost half of the 167 million square feet of new U.S. warehouse space currently under construction, the equivalent of over 70 million square feet is already pre-committed to new tenants. The tenants are described as primarily E-commerce, third-party logistics and retail industry users, no doubt responding to exploding needs for online fulfillment capabilities. 

Further noted is that current ratio of space under construction that is pre-leased stands at 43 percent, which exceeds the 17-year average of 38 percent. Obviously, the ratio signifies a healthy momentum and zeal on the part of online logistics and customer fulfillment teams for warehouse and fulfillment space acquisition.

We are of the view that such space trending and building momentum should be viewed with a cautionary lens. Here is why.

As a long-time industry supply chain analyst, my view of warehouse space has been admittedly as a skeptic. Warehouses, particularly very large ones, are monuments and reflections of inefficient supply chain inventory and customer fulfillment management. However, the boom in online B2C and B2B fulfillment has added a newer dimension for warehouse space, namely a tradeoff of overall physical retail space for that of warehouse space. A further market influencer is no doubt Amazon, which continues to consume new warehouse and distribution space. Adding to the challenge for some brick-and-mortar retailers is the need to simultaneously support both traditional store inventory replenishment and growing online fulfillment needs.

For the most part, prior warehousing and distribution strategies were predicated on supporting physical store or distributor inventory replenishment needs. Warehouses were maximized for vertical height vs. square footage, reflecting maximum inventory storage in a concentrated dimension.  Replenishment orders, for the most part, called for pallet-loads of inventory and merchandise shipped to individual retail stores or wholesale distributors. Inventory could thus be stacked higher in warehouse racks, with automated material handling cranes and equipment providing the bulk of warehouse pick automation.

Online fulfillment centers support a different strategy, namely far higher numbers of individual online orders that feature single cartons or packages. Thus, today’s specialized online customer fulfillment centers are now highly automated examples of end-to-end inventory flow-through, where bulk inventory is received and stored in building flow-through configuration, and where pickers or robots, perform pick and pack needs, while highly automated conveyors flow individual shipments to the other end of the building for actual shipment to online customers.

Online fulfillment is a trade-off of required real-estate square footage with the assumption that the customer fulfillment center assumes the real-estate burden of physical stores or distributors. Thus, the need for fewer overall physical stores, but new investments in customer fulfillment logistics and lower-density warehousing that focusses more on order volume productivity. The one continually changing variable will always be assumptions for inventory needs.

Where this tradeoff is tricky is in the cost and footprint of overall physical space, as well as the cost of such space.  Real estate market supply and demand dynamics can often inflate real-estate and subsequent leasing costs, especially when retailers like Amazon and Wal-Mart are leading the charge. As we all know, today, the cost of capital continues to be rather low. What if that changes over time, particularly in the costs of large footprint warehouse space vs. that of traditional shopping mall or retail space. The other looming challenge is the increasing costs included in online fulfillment, including added inventory, transportation, and logistics costs.

Such trends are complex and the takeaway for supply chain and online customer coordination and fulfillment professionals is that major decisions on real estate cannot be made in isolation.  They are not the context of a supply chain functional decision alone. Rather, thorough, rigorous business-wide analysis and review as to longer-term strategic business implications is very important. By our lens, the firm’s CFO and the head of supply chain are key stakeholders as well as stewards for such decisions.

The last thing that retailers need or desire is to tradeoff cheaper fixed or variable physical store real-estate and store operating costs for even more expensive online fulfillment costs. Likewise, supporting traditional stores and online needs with different or redundant footprints is no longer efficient nor cost affordable. Compounding the strategy are decisions to entirely outsource online customer fulfillment to an experienced 3PL, but here again, logistics providers are subject to the same market supply and demand dynamics.

At face value, exploding demand for warehouse space is not surprising. Such dynamics are the elation of warehouse design, construction, automated systems and real-estate providers.

Thorough analysis of the cost and service tradeoffs for implementing a widescale online customer fulfillment model is a business-wide joint responsibility involving multiple stakeholder inputs.

 

Bob Ferrari