DCs – Centralize or Decentralize?
Combinations of factors that make all the difference in this decision making
This is an intense academic and professional discussion in the areas of Administration and Logistics. There is no consensus. What there is the analysis of specific situations. Each company with its reality. But some aspects can be analyzed when making such a decision.
If we use the SCOR (Supply Chain Operations Reference) as a reference model, we will have to analyze five macro processes to choose between the centralization or decentralization of the DCs: Planning, Supply, Production, Delivery and Reverse Logistics. All these areas will be hit. But, certainly, the Delivery sector would be one of the most affected, as it deals with delivery flows.
Aware of this, the entrepreneur should pay attention to seven points:
- Logistic operating costs;
- Tax Aspects;
- Traded volumes;
- Availability of products;
- Time dedicated to delivery;
- Customer satisfaction rates regarding the delivery process;
- And the quality of the products made evaluate to the end customer.
At first glance, it looks like pure mathematics. Whatever is most rational from a financial point of view and speedy in customer service should be applied. However, it is precisely in this combination of factors that the calculation gives way to the subjectivity of the analysis of a concrete case.
It is logical that the financial cost has a considerable weight in this decision. However, taking an attitude that displeases the clientele can lead the company to bankruptcy. Sometimes, it is better to send the product by plane from a single CD to the end customer than to have a network of Distribution Centers spread across the country, immobilizing resources or consuming high amounts in rents. On the other hand, depending on the product marketed, being close to the customer to carry out the Same-Day Delivery strategy can please consumers so much that sales would increase and profits too, depending on the amount spent on the operation.
According to an article published in December 2016 in Revista de Produção Online, from Florianópolis (SC) and written by Gilberto Marassi de Loiola Leite, Bruno Beiler, Carolinne Ferreira, Thomas Kors and Paulo Sérgio de Arruda Ignácio, all UNICAMP students, the points “that interfere with the degree of centralization of finished goods inventories in a supply chain can be summarized in four characteristics:
- product turnover: Products with high turnover absorb smaller portions of fixed storage costs and have lower risks of perishability and obsolescence, therefore they tend to be indicated for decentralization (TORRES, 2003; VIEIRA, 2009; WANKE, 2011);
- service time : As service times (time between placing the order and receiving it by the customer) increase, decentralization tends to be advisable in order to be more agile. It must be evaluated whether the opening of a new distribution center more than offsets the opportunity cost of keeping the stock in transit that would be generated with centralization (TORRES, 2003; VIEIRA, 2009; WANKE, 2011);
- service level : Similar to the analysis that must be done for the response time, the higher the service level, the greater the tendency of decentralization in order to locate the products closer to the customer (TORRES, 2003; VIEIRA, 2009; WANKE, 2011);
- acquisition unit costs : The higher these costs, the greater the tendency towards centralization due to the high opportunity cost of maintaining these decentralized stocks (TORRES, 2003; VIEIRA, 2009; WANKE, 2011).”
Even though it was written five years ago, before the brutal changes imposed by the COVID-19 Pandemic, the authors’ line of reasoning remains valid and with a strong academic foundation. In the same article, students from the Faculty of Applied Sciences at UNICAMP highlight the use of the AHP Method (Analytic Hierarchy Process), developed by “Thomas L. Saaty in 1980, which helps the decision-making process by dividing the problem into hierarchical levels, with based on the knowledge and experience of those involved in decision-making (BELFIORE and FÁVERO, 2012).” This tool is based on the MCDA (Multicriteria Decision Analysis) methodology.
Among these multi-criteria, the following stand out:
- “building acquisition costs: are all the costs involved in the acquisition of the DC(s) or with their rentals;
- tax incentives: the location of the central DC can bring benefits to the entire operation or, when this is not possible for reasons of another nature, the network of DCs can bring partial benefits related to the units installed in regions where the incentive can be granted ;
- Safety Stock / Inventory Keeping: A decentralized operation tends to keep total safety stocks (i.e., the sum of all regional safety stocks) greater than what would be required in a single DC. In addition, or perhaps as a result of this characteristic, inventory maintenance costs are also higher in distributions that use a network of CDs;
- administrative and personnel costs: administrative costs are increased in a DC network configuration, as is the cost of personnel, since some tasks and functions that are performed in a specific way in a single location are replicated for each unit: it can be said that the centralized structure is leaner in these aspects;
- risks inherent to the location: it is to be expected that each region is subject to its own risks, such as those related to security, lack of labor, incidences of natural disasters, quality of public infrastructure, etc. In a distribution network, this risk is diluted, but precisely because of this, the chances of occurrence at some specific point increase. By centralizing the operation, the risk decreases, but the effects of its occurrence tend to be more harmful;
- stock imbalance: if there are no efficient and integrated controls, the risk of stock imbalance in an operation involving several distribution units increases. It is up to the decision maker to analyze whether this characteristic may represent a problem for his organization;
- freight costs: in general, a distribution originating from a single point generates fractional freight costs for national distribution, which are normally carried out by third-party carriers, due to the need for a more capillary distribution network. For regionalized operations, the costs are composed of consolidated transfer freight (closed loads, which can even be carried out with their own fleet) to the DCs, and local distribution from this point on. It is necessary to analyze which composition is more economical, but very commonly the network operation has a lower transport cost;
- perishability / obsolescence: if the product, due to the characteristics of its own composition or market, has a reduced durability period, either due to perishability or obsolescence, it is highly recommended that its availability be more agile, which is better guaranteed through a regionalized distribution;
- product turnover: higher turnover products reduce storage costs, but require frequent and constant availability, and therefore a distribution network structure is more suitable for products with these characteristics;
- transit time / fleet availability: centralized operations may have longer transit times if the customer coverage area is quite dispersed;
- risk of supply disruption: like any dilution of risk, the establishment of several DCs presents two biases: on the one hand, the risk of a supply disruption is divided among the DCs, even enabling operational service strategies between the units in case of some punctual failure and thus reducing the damage; on the other hand, the possibility of its occurrence is multiplied by the number of units, which demands weighting on this aspect;
- market sensitivity to term: there are markets in which sensitivity to delivery time is greater than others, such as markets that do not manage retail inventories, or with a type of sale associated with the service, such as auto parts, IT, etc. Other markets consider agility to be important, but this is not a decisive factor or a cost generator, such as clothing, shoes, books, etc.;
- reverse logistics: a distribution network greatly increases the efficiency of reverse logistics operations, due to the proximity of the structure to its consumer markets, which facilitates collection and can reduce freight, if the intention of the return is a specific disposal, for example.”
From the above excerpt, academic references and some phrases have been removed. Even so, the authors’ observations are enlightening for those who are in doubt whether to centralize or decentralize their Distribution Centers. Again, in a superficial analysis, one gets the impression, especially in the new normal imposed by the Pandemic, that the decentralized structure is better to serve the consumer. But it can have a higher maintenance cost, with multiple physical structures and employees. Is the customer willing to pay for it? It depends on the client’s budget and how fast he is. Yes. In other words, the Target Audience must also be taken into account. A prime clienteleit is different from those who look for the internet only with the aim of saving money. After all, who are you selling it to? All are good consumers. They just have different profiles. On the other hand, a structure with centralized DCs, in addition to offering lower costs, is easier to manage.
Finally, it is important to highlight that the entrepreneur must keep in mind what he is selling. What is the nature of your product? Do SKUs have high added value? Is the degree of obsolescence low? And what is the contribution margin (the difference between cost and final price)? Depending on these and other answers, the entrepreneur will know which strategy to adopt.