Looking for the next frontier of margin enhancement? Think structurally

The pandemic forced many firms to rapidly expand and modify their supply chains. Capacity investments were made to meet surging demand and accommodate the inventory required to meet accelerated forecasts. Costs spiked in freight, labor, and raw materials. Price increases were used to offset inflation and increase margins.  As demand normalized, firms executed opportunities to reduce supply chain costs, but productivity gains became harder to capture. In a good illustration of this cycle, Macy’s converted stores into mini-fulfillment centers in 2022 and is now downsizing and shifting to automation to cut costs.

Price increases have led to volume declines in many businesses as customers have hit a spending ceiling. Recent year-end reporting highlights this trend: January 2023 saw Proctor & Gamble’s average sales price grow 7% versus December 2023’s 3% rise. As shown in Figure 1, from 2021 to 2023, CPG companies raised the sales value of their goods by 13%, while sales volumes declined by 6% over the same period.

Meanwhile, higher input costs continue to challenge CPG company margins. Labor and energy, two driving factors of product costs, continue to increase. American labor costs are up 4.2% YoY, while the Energy Price Index reflects more than a 100% increase since pre-Covid levels. At this stage, inventory is either leveling off or remains elevated, consumer demand remains relatively flat, and freight rates have troughed. The product of these dynamics is a reality where many firms have been left with an inefficient distribution cost structure misaligned with their forward-looking forecast and strategy.

To drive the next phase of cost reduction, companies must think structurally. In our experience, network redesign can help companies reduce supply chain costs by 8 to 15% and inventory requirements by 5 to 15%.

Here are key considerations (figure 2) to think through as you approach network optimization:

1.  How should channel dynamics and service-level requirements be considered? How should the network be designed to account for continually evolving requirements?

Service-level requirements will vary across channels, depending on the business model: wholesalers, distributors (who need full-pallet and full-truckload capabilities), retail fulfillment (partial-pallet and less-than-truckload shipments), and e-commerce companies (which deal more with parcel shipments and each-picking fulfillment) all have unique requirements to be considered. As business models have evolved, many companies now serve multiple channels within their network, although their network has often not been natively designed to serve all of the channels. As an example, e-commerce grocery, flagged by many as the “future of e-commerce,” is predicted to grow by 17.4% in 2024, according to one agency, and demands different infrastructure than legacy wholesale and store-fulfillment channel requirements.

The 2023 AlixPartners Home Delivery Report found that free delivery continues to be a heavy influence on consumers, playing a critical role in 96% of purchasing decisions. Moreover, one-third of executives said it was dilutive to profitability due to split shipments, damaged goods, disappointed expectations, and other factors. The food category saw a slight lift in demand but brings with it a higher potential for damage or spoilage.

2.  What do the volume forecast and associated capacity requirements say?

This will depend in part on whether a company is pursuing organic or inorganic growth; rapidly scaling or looking for deeper footholds in a given market; funding a strategy with serious marketing dollars or going in pursuit of customer loyalty.

Companies should also consider a deep analysis of the SKU portfolio using marketing and sales data. Determining category leaders and laggards can allow input rationalization and reduce storage requirements. This can also inform inventory placement and deployment strategies that reduce inventory levels. 

Capacity requirements should directly correlate with projected inventory levels and throughput inputs (e.g., seasonality, promotional surges, etc.). Organizational alignment on policies such as “just in time” versus “just in case” is also a key input to projecting the optimal network capacity. Inventory, once viewed as a working capital consideration, has escalated to a major driver of operating costs.   

Balancing capacity with both short- and longer-term demand projections is not an easy task. Companies should think about the network in phases, and how various footprint strategies can preserve agility while optimizing cost-to-serve as the business grows.

3.  Where do you need capacity? What missions should distribution centers have in an optimized network of the future?

Decisions around how best to lay out manufacturing, co-packing and distribution locations will impact agility and productivity. In order to optimize the entire network, companies need to think about the integrated supply chain—sourcing origin through final-mile delivery. For example, manufacturing hubs located in Asia have different proximities to ports on the West and East coasts. Injecting consolidation or deconsolidation operations into the network could unlock more economical inventory replenishment to the East Coast.

Domestically, population shifts have changed the value of localized distribution and manufacturing facilities. For example, population growth in the Southwest and mountain states has driven clients to place distribution centers (DCs) in key central markets such as Dallas and Kansas City. These locations often serve multi-mission purposes, acting as key nodes to fulfill local demand and also supply replenishment to other nodes within the greater network.

Lastly, companies should also consider the top-line costs to customers and shippers when thinking about DC and inventory placement. Research by Adobe Inc. found that in 2022, 20% of grocery orders featured curbside pickup, while the vast majority of customers surveyed in the 2023 AlixPartners Home Delivery Report expect free 3-day delivery of goods.

4.  What role should third-party logistics providers play in the future network?

In 2024, Krispy Kreme announced a pilot program using a third-party logistics provider in Los Angeles and Washington, D.C., though customers will still see Krispy Kreme trucks doing the deliveries. Leaps in automation and demand in this space have driven significant growth for many of North America’s larger third-party logistics providers. As a result, entering new markets or standing up a new DC is now easier and faster than 10 years prior. Partnering with a third party has become a key accelerator for the implementation and risk mitigation of network-related changes.

5.  What are the risks and tradeoffs associated with flexibility?

Maintaining network flexibility doesn’t mean a company must carry excess capacity. Today’s warehousing market presents opportunities to take down a fixed amount of space in a desirable location over a longer period or commit to variable space that may range in terms of time commitment (e.g., purely variable, short-term). 

Companies need to consider factors in determining the right facility strategy, including debt capacity, accounting preferences (e.g., balance sheet versus income statement), and market-specific conditions (e.g., sub-lease outlook, trends in rates). A thoughtful facility strategy and carefully negotiated contract terms can ensure both flexibility and an optimal cost structure for your future-state network.

Capitalizing on an inflection point

The network design process can also provide valuable insights into other operational and execution improvement opportunities within the supply chain. These EBITDA improvement opportunities, along with the working capital benefit, can potentially fund investment to execute on your network design roadmap.

The pandemic era of structural build-out was largely a reaction to unscripted demand and supply constraints. Deploying capital for unneeded warehouse space is part of yesterday’s playbook; we advise starting with a clean-sheet approach to evaluating their supply chain, refining their network design through an iterative, collaborative approach: Less theoretical, more pragmatic! In order to truly optimize on both service and costs, chief supply chain officers must evaluate their network from an end-to-end perspective.

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