DHL RESEARCH BRIEF THE NEW LANDSCAPE OF SUPPLY CHAIN REAL ESTATE. DHL Supply Chain

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1 DHL RESEARCH BRIEF THE NEW LANDSCAPE OF SUPPLY CHAIN REAL ESTATE DHL Supply Chain

2 2 EXECUTIVE SUMMARY Global and regional supply chains are changing, as they adapt to the new realities of commerce and competition. Companies are re-thinking their go-to-market strategies and, as a result, making different choices about how they locate, design and operate their distribution networks. In late 2016, DHL Supply Chain conducted a series of qualitative interviews with senior supply chain professionals to discuss the trends that are re-shaping distribution real estate strategies. The key takeaway: A major shift is underway in how businesses deploy real estate to support their operating strategies. This research report discusses that shift what s driving it, and how it impacts distribution networks and the way in which they are managed. PART 1: VOLATILE TIMES KEY TRENDS 2015 and 2016 were strong years for the industrial real estate sector. Demand was high and appears likely to remain so for 2017, according a recent survey. 1 While a healthier global economy fuels the demand for supply chain real estate, it is not the only driver. Four other forces are at work, and they are having a transformational effect on companies distribution center (DC) networks. They include: n The e-commerce revolution n Globalization and right-shoring n Mergers and acquisitions The e-commerce revolution The explosion in e-commerce worldwide is revolutionizing not just retail, but all industry sectors. Why? E-commerce has irrevocably changed customer expectations. They demand near-instant service/delivery, lightning fast order turnaround times and perfect execution, all while having full visibility into the process. These high service expectations are having a bleed-over effect in more traditional industry sectors like technology, consumer products, heavy industry and life sciences. Companies of all kinds now face the same sets of service expectations as e-commerce retailers, putting tremendous pressure on supply chains to perform. If they don t perform deliver up to the minute as specified in their service level agreement they are penalized by compliance fines. Our customers are requiring shorter and shorter order lead times, reports the U.S. supply chain director of a global consumer products firm interviewed for this research. They expect delivery on a certain date and a specific time, and they penalize us if we don t perform. This means we re having to revisit our supply chain network and re-think our strategy so we can be completely consistent. We have to up our game. E-commerce carries another ripple effect it changes a lot of companies last-mile delivery strategies. Many companies in my industry are starting to consider changing their go-to-market model, says one pharmaceutical supply chain executive. They re looking at whether they still need to go through distributors, or simply ship direct to customers. Depending on which direction you go, it has a big impact on your distribution network. n Technology innovation 1

3 3 Globalization and right-shoring Twenty-five years ago, manufacturing strategy revolved around outsourcing production to China and other low-cost labor centers. Supply chains became geographically extended, unwieldy, tremendously complex and risky. All of that is changing. Global corporations are finding that manufacturing 8,000 miles away from their customers no longer makes sense in many cases. For a growing number of products, the risks in terms of cost, lead times, responsiveness, and customer service outweigh the benefits. Companies, as a result, are reengineering their production and supply networks, moving away from super long-distance supply chains to globally local supply chains. This means sourcing and manufacturing closer to customer demand in a strategy referred to as right-shoring. Businesses see right-shoring as a means to realize powerful benefits, including: n Reduced lead times Mergers and acquisitions Mergers and acquisitions (M&A) have a direct and significant impact on real estate strategy and operations. They force supply chains to blend and rationalize their physical networks, a complex process than can go on for years. The technology and life sciences/healthcare sectors were particularly affected by M&A activity in the last two years. In technology, second quarter 2016 set a record for the most deals at or above $1 billion. But that number was surpassed in the third quarter, according to consulting firm EY. Figure 1 shows tech sector M&A statistics for third quarter FIGURE 1: TECH M&A DEALS IN M&A deals completed in Q deals worth over $1 billion $155.5 billion aggregate value of completed M&A deals, making Q the third-highest dollar value in deals ever $55.2 billion invested by buyers outside the tech sector n Lower inventory costs n Better service for customers n Improved agility n Faster recovery time after supply chain disruptions n Reduced carbon footprint, and n An improved bottom line Right-shoring gives us flexibility the ability to customize product and orders closer to the customer so we are not sitting on inventory that is not attached to orders, says the supply chain director for one consumer packed goods (CPG) company interviewed for this report. However, we have to balance inventory savings against the fact that right-shoring usually involves higher piece prices due to higher labor costs. So we may decide to pay a little more per piece to gain speed, service consistency and the ability to customize nearer the end of the order cycle. Figure 1 shows the number and value of M&A deals completed in the technology sector worldwide for third quarter Source: EY, 2016; Truly successful M&As are hard to come by. Failure rates are extremely high, according to Llamasoft, a network analysis applications developer. Depending on which report you consult, M&A initiatives in general have a failure rate of anywhere between 50 and 85 percent, the software company notes. Failure to consider the synergies and redundancies of the end-to-end supply chain of both companies is arguably a top contributor to the shortfall, it continues. Redundant facilities, assets, suppliers, customers and products can put a significant drag on profitability and efficiency. Leading companies, by contrast, take an aggressive stance on blending, upgrading and rationalizing their real estate portfolios in order to drive M&A value. They view it as an opportunity to re-think their physical network, shedding facilities that don t fit well into the new supply chain, and adding new facilities that support an efficient, merged supply chain.

4 4 Technology innovation Supply chain technology has come of age. At a strategic level, thanks to big data, smart analytics and new visibility tools, companies are no longer relegated to running their business by looking in the rearview mirror i.e., managing based on weeks- or months-old information. Organizations can now get out ahead of their business and direct their global operations to be far more predictive and proactive. Key reasons for doing so include: n Raising customer service expectations n Getting closer to the customer n Reducing lead times n Gaining greater flexibility and agility These smart technologies affect companies distribution networks in two ways. First, they may change distribution center (DC) location strategies to position inventory with more certainty, based on better demand analytics. Second, they accelerate the speed with which companies can respond to changes in demand, markets and customer requirements. The real estate network must be able to flex and flux in tune with these dynamics. On a tactical level, technology is changing what goes on inside the four walls of the DC. Augmented reality, robotics, vision picking these and other innovations support higher productivity and lower costs. As a result, more companies are interested in deploying these technologies in their DCs. PART 2: VOLATILE TIMES REAL ESTATE RAMIFICATIONS What steps are companies taking to address these trends in their supply chain networks? Interviewees discuss three key action areas. 1. Redesigning the footprint Five years ago, says one study participant, we reduced the number of DCs in our domestic network. But the pressures caused by e-commerce and rising customer expectations are forcing us to re-think that strategy to set up more DCs so we can be closer to the customer, reduce lead time, and gain greater flexibility and service consistency. Thus, while companies may still operate large mega-regional DCs, they now supplement them with smaller, satellite DCs positioned closer to the customer. The fact is, companies are adding more, smaller DCs to their supply chain networks. n Improving service consistency As a corollary to this responsive network model, companies also want to be close to trade zones and large national or international transportation hubs, such as Memphis, Tennessee in the United States. This enables next-day delivery. 2. Sharing platforms and services As they grapple with pressures to reduce risk and cost, and increase agility, more companies are looking at a shared real estate model for their distribution centers. There are several reasons for this, as interviewees note. If we re following the Amazon service model of 24 hours or less, says one life sciences company, we would need to have more warehouses or DCs closer to those customers. That would become potentially cost prohibitive, so we d look to leverage more of the common network of third party logistics firms (3PLs). The same would be true in leveraging the 3PLs capability in last-mile delivery. Regulations may play a role as well. One pharma manufacturer explains: We are a highly regulated industry, and as a result have additional forces affecting our network requirements. Many countries require us to have a physical presence in order to sell to that market. That makes it hard to reduce our footprint. So we re looking at locating in more shared 3PL facilities to mitigate some of the cost impact. Mitigating supply chain risk is another reason companies look to shared networks. We are constantly looking to map our DC network so there s less risk of disruption, says a CPG company participant. If something happens in one location, we want to be able to immediately switch fulfillment to an alternate location. This takes a broader and more agile network, and it s something we would look to a 3PL to provide.

5 5 The real estate portfolio, thus, is set up to provide alternate capacity situated in different locations. While this hedging strategy may ultimately mean more facilities, the trade-off benefits of assured, uninterrupted business operations outweigh the incremental costs. Here again, a shared network gives companies the benefits of contingent capacity while leveraging the lower costs inherent in shared facilities. 3. Changing what s inside the box This is not the age of your father s distribution center. Too many variables have changed, not the least of which is technology. The companies interviewed for this research report indicate they are looking to deploy what s next inside the four walls of the DC and do so intelligently with the aim of reaping the potential benefits they afford. Observes a CPG company: We need to catch up with DC technology like vertical lift modules, AGV carting, augmented reality and voice picking. We can t do this on our own. We are looking for our 3PLs to invest in these kinds of solutions and figure out how to use them to our advantage. The purpose of this catch up is to capitalize on the potential cost savings and efficiencies gained from blending new technology with more traditional DC operations and labor management. We are looking for technology to help us improve efficiency within our distribution center network so we can offset some of the increasing costs we incur in meeting our higher customer service requirements, notes another study participant. So technology is a big priority for us. PART 3: MANAGING REAL ESTATE OUTSOURCING MODELS In this landscape of change, the job of managing network real estate is a lot more complex. For this reason, interviewees increasingly turn to outside experts for help. These experts come in several forms, including network design consultants, real estate brokers and 3PLs. Why use outsiders? The answer is simple. Unless they have massive demand and a constantly-changing real estate footprint, many organizations don t have the skills, knowledge and resources to manage their real estate needs entirely in-house. We are not real estate experts, nor do we want to be, says a CPG company interviewee. We don t do a lot of the real estate procurement or facilities management in-house. We don t have the internal resources to manage these kinds of activities. Another company performs network analysis in-house, with support from a specialized network analysis consulting firm. That s a strategic function for the company, so we won t outsource it entirely, the supply chain director indicates. Once we identify a location, then we engage with the 3PL and have it find the property and manage it. Bundled or unbundled Real estate services come in two basic packages: bundled or unbundled. Unbundled services generally are provided by a real estate brokerage firm and do not include operating the facility. Bundled services, provided by a 3PL, include the real estate aspects but add facility design, operations, labor management, transportation management and the like. Deciding which is the right real estate outsourcing model depends on multiple variables, but most companies seem to adopt a blended approach to their supply chain real estate activities, according to one study. Increasingly, though, these same companies are looking for providers to supply greater value-add in their services and solutions. Occupiers want assurance that providers not only have the right geographic and market coverage, but also the right technology, tools and processes across all services. 2 Study participants use both unbundled and bundled services, but believe a bundled approach offers some valuable benefits: n When you manage a real estate contract, you have to deal with the landlord, utilities, operational issues and so on. We don t have that capability in-house. And we don t want to carry that overhead or have that management headache. A bundled 3PL may appear to be more expensive than doing this in-house, but once you factor in all the costs associated with building internal expertise, it is not. 2 Global Trends in Real Estate Outsourcing. Cushman & Wakefield )

6 6 n We want a total cost picture, not just lease rates and price per square-foot. We want to know about labor, energy, transportation, DC layout and operation, warehouse management systems, and so on. We want someone who can factor all that in and give us a total cost. n We expect the 3PL to find the facilities, deal with the landlords, negotiate pricing and then provide us with some ranked options, based on the guidelines we established. We rely on the 3PL s specific knowledge of the area and market, and its understanding of how our supply chain works, to provide this ranking. That s valuable for us. A STRATEGIC DIFFERENTIATOR The face of global supply chain networks is changing. Gone are the days of operating a static real estate portfolio and tweaking it every five to seven years. Business is too dynamic and the stakes are too high. The fact is, in the past few years, the way companies manage their supply chain real estate portfolio has morphed from a tactical/operational concern to a strategic differentiator. Supply chains that operate more nimbly and at lower cost don t just save money. They drive growth. Operating a distribution network to deliver on that promise requires robust real estate management capabilities that range from site selection and lease management to facilities operation. As the companies interviewed for this research indicate, partnering with an integrated 3PL, one that is expert in both operations management and real estate, can provide a powerful solution. Do you prefer to own or lease the distribution facilities? The answer is, it depends. One company interviewed leases all of its DCs through a 3PL. Our finance team doesn t want the liability of ownership, notes a pharma company study participant. Another firm uses a blended approach. In some cases, depending on the market and size, it is better to have the 3PL own or lease the building, the supply chain VP says. In other cases, depending on the country and product, we prefer to own the lease. WHAT DO COMPANIES LOOK FOR IN A BUNDLED 3PL PROVIDER? Quantitative research study participants cited the following qualities as important in their 3PL service providers: n A department devoted to real estate exclusively n Proven ability to evaluate all viable real estate alternatives and provide a total solution n Bandwidth and capacity n Advanced knowledge of markets, locations, buildings, labor, taxes, transportation, technology, etc. n Extensive track record with customer success stories n Ability to leverage resources and facilities across multiple customer operations in order to address volume fluctuations and reduce costs n A wide range of square footage under contract n Demonstrated ability to manage a large and complex real estate portfolio n Operational excellence M&A: HOW ONE PHARMA COMPANY USES A 3PL In a merger or acquisition, systems and networks must be merged quickly and economically in order to realize the value of the transaction, says the supply chain head of a life sciences company. A company like ours depends heavily on 3PLs to help with this. 3PLs can add more value by offering quick turnkey solutions to integrating the companies in our network. Systems are the hardest thing to integrate, the VP continues. We don t have a standard way to hook new company systems into our systems even if we are working on the same ERP or other platform. Everything is hard. So we asked ourselves, Why spend tens of millions of dollars to integrate our supply chain systems when we can simply use a 3PL s systems (WMS, TMS, visibility, etc.). There are still issues to resolve, like who owns the data, and how good is our access to it. We have to work those out with the 3PLs.

7 7 For example, in developed countries like the United States where we have a lot of business and we operate a very large facility (950,000 sq. ft.), we know we will be at 80 to 90 percent capacity utilization because of our high volume. In that case, we choose to own the lease because that means our costs will be stable and predictable. In a less stable market, though, where we think we may need to move in a few years, we want more flexibility so do not hold the lease. Who makes the real estate-related decisions? The final decision on a real estate matter rests at the vice president level or higher in the companies interviewed for this research. Reports one interviewee: Our supply chain head makes the location and number-of-facilities decision. Our CFO weighs in on the lease-versus-own decision, considering our legal and financial obligations. Says a pharma company: Usually this effort is run by our sourcing procurement operation. The final decision is made by our regional vice presidents, backed up by our operations people.

8 For further information Please contact dhl.com/realestate