As we begin 2011, most logistics CEOs are feeling slightly more optimistic about their business prospects than they did at this point in 2010. The question is whether they are ready to invest in DC improvement projects this year or will continue to play the wait and see game.

It’s a safe bet that even among the most optimistic companies, getting almost any custom designed DC system improvement or expansion project approved is going to involve some handwringing and extra effort. Possible exceptions would be for purchases of “off-the-shelf” or pre-engineered equipment that can be plugged-in and turned-on. In that case risk is much lower as companies can reasonable expect immediate savings following the lump sum investment.

Based on interviews with logistics executives, as well as feedback received from various Supply Chain Digest surveys, it is clear that logistics executives, while appreciating the potential benefits an integrated system project offers for their operation, are understandably skeptical of ever actually realizing the projected ROI.

This is in part due to 2 factors – project disruptions and market volatility. For example, the cost for design engineering, progress payments, installation and commissioning for the typical system project are normally spread over several months or even years before the project is completed and benefits begin to be realized. During this extended period of time all sorts of unforeseen changes can, and usually do, take place. Therefore, getting these projects approved requires acknowledging that there will be disruptions (both internal and external) as well as cyclical business fluctuations.

Stuff Happens

Anyone who has ever been involved in a custom designed project, especially one that is spread over a lengthy period, knows that there will be unforeseen issues. Still, there are some issues like cost escalation and the inevitable delayed start-up that should be recognized and accounted for.

Start-up delays, for whatever reason, are perhaps the most common, and most insidious, project event. The loss of expected savings in the first year of system operation, probably accompanied by additional cost for de-bugging and temporary workaround operations, can erode the ROI dropping it below what would have been approved in the first place.

A little investigative research (talking to companies who have recently completed a similar project) will reveal other common ways to disrupt a projects return, such as; factory errors, equipment delivery delays, design errors, and user requested change orders. A conservative contingency fund here might be a good idea especially if the project involves prototype equipment, higher levels of picking and shipping automation, or entirely new methods.

Reliability, availability, and maintainability are commonly used concepts among material handling industry consultants and suppliers. However, they maybe simply relying on intuition and experience, and hoping the system is designed well enough to meet these goals.

Consider asking the following questions:

• Is the system robust to variation in operating conditions?
• Is it modular and, thus, easy to repair?
• If one component fails, does the whole system fail or can other parts still operate?

Knowing the answers to these questions will help you answer other questions like:

• How many repair technicians should I staff?
• How many spare parts do I keep on hand?
• How often do I do preventive maintenance?

Vanishing Savings

Then, as if all of that’s not enough, there’s the matter of vanishing or unrealized savings. This is due to the crystal ball factor. Typically, the project will be designed to handle forecasted sales demands for some time in the future (3 to 5 years). Therefore, the actual annual savings will fluctuate with volume, usually beginning small in the first year, and then gradually ramping up as business volume increases. This growth factor projection would have been included in the initial ROI calculations. However, if the sales forecast is flawed, or if market volatility and/or business conditions change such that the projected annual volume levels never materialize, that too will reduce the actual ROI. A contingency factor here, big enough to offset the difference, will probably kill the project.

In the final analysis, you are left with trusting (or betting) that the sales forecast is realistic. Whereas manufacturers can tolerate much longer payback periods, distributors, especially those in retail, prefer projects that are expected to payback in 2 years, or less.

Mitigating the Risk

There are design, construction, and financial risks in every project. But, there are also substantial business risks in being too conservative relative to adopting advances in technology that are proven to increase throughput and lower per piece handling cost. The best approach is to observe the following principles when working through the financials of your project.

• If the project won't fly with a realistic budget that includes appropriate contingency levels based on the projects risk level, then don't start it.
• If the system is large or especially complex, consider dividing the project into steps or phases that are more readily manageable. This approach also allows for some adjustments to be made to future phases to accommodate business, system design, and/or operational changes.
• Time is money. If you are concerned that the bidders may be making overly aggressive project completion promises, consider including a performance incentive for early completion and a penalty clause for overrunning the promised schedule.

Note: By adding this clause after the competitive bidding process, but prior to vendor selection and execution of the final contract, vendors will not be able to hedge on their proposed project completion date. If they object, then you should increase the project timeline and adjust the ROI accordingly.

• To help ensure that your project stays on budget and on schedule, an experience Project Manager (PM) must be a key player throughout the design and implementation phases. A PM is most often included as part of the vendor services. But, you need to understand that the vendor’s PM works for the benefit of the vendor. To increase your comfort level, you can hire a consultant or industry expert to provide independent PM services and/or vendor oversight. See – Who is really in Charge of Project Management for your Materials Handling System in Distribution?
• Be sure to budget for training and some extra help at start-up to avoid costly errors and missteps. See – Optimizing DC Performance Requires Properly Trained Operators.

This last point cannot be over stressed. An internal startup support task force should be assembled well in advance of the project completion date. The mission of the multi-discipline task force is to provide all the technical and management resources needed to keep the project moving forward and on schedule.

Planning for the task force early in the life of the project helps to ensure that the right personnel are available when they are needed. When people unfamiliar with the original planning and system design are brought on board in the late stages of the project, there is a danger that overall system objectives, no matter how well documented, will not be fully understood or properly supported and implemented.

Final Thoughts

There was a time when “dam the torpedoes – full speed ahead” was a much appreciated, albeit somewhat macho strategy. While the entrepreneurial spirit is still strong, it has been tempered by the need to survive to fight another day. By knowing what you know, and planning for what you don’t know, you can have your cake and eat it too.

Good luck and best wishes as we move forward into 2011.

Agree or disagree with Holste's perspective? What would you add? Let us know your thoughts for publication in the SCDigest newsletter Feedback section, and on the website. Upon request, comments will be posted with the respondent's name or company withheld.

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