How to Justify an Automated Warehouse.

Warehouse automation requires a large investment of time, talent, and money. Historically, automation for made sense in high-turn operations, often plant-attached, operating 24x7, and in areas with expensive or hard-to-find labor. The world is changing rapidly. Visionary operators and investors realize that even efficient conventional operations will be a liability in the not-too distant future. Let’s explore “how to justify an automated warehouse”.

This article will be focused mainly on warehouse automation for handling pallets, but the concepts apply for case handling and each pick operations. The focus here is not what technology type is better or which supplier is best: this article focuses on HOW and WHY to justify warehouse automation, not with WHAT or WHO.

Before diving into the details, we should acknowledge a few elephants in the room:

1)?????Justification ≠ Investment. On paper, justification for automation is often labor savings. Labor savings rarely CAUSES investment. Companies don’t spend millions to save a few percent years from now. Motivation to get ahead or fear of falling behind is what writes the checks. Want to be relevant 10 years from now? You need automation and you need to start now.

2)?????Automation initiatives are risky. Overconfidence leads companies to make investments in solutions they don’t fully understand. Many suppliers are developing cutting edge technologies and are pressured to achieve aggressive sales targets, resulting in risky solutions. Every user has a different threshold of pushing the boundaries of automation to maximize the benefits. The last 20% efficiency gain may add 80% of the project risk.

3)?????Despite the risks and motivations, it is a fact that warehouse operators are faced with a declining labor force, increasing wages with a decreasing labor pool, and 100% employee turnover for many positions. ?At the end of the day, does ROI matter when it comes to remaining in business? If failure to invest results in loss of business and competitiveness, how should that factor into the ROI vs. “just savings”? Avoiding automation = eventual irrelevance

Automation suppliers have the usual list of justification factors cited as benefits and reasons to consider automation. The challenge is that many of those factors have hard to pinpoint value, or are justification factors that could be achieved through alternate means (process optimization, improved software, etc.) without large investments in automation.

This article will provide examples where investment in automation is marginal and when it makes good sense. Of course, it makes a difference whether the warehouse is plant-attached or off-site warehousing and distribution. This article is mainly focused on off-site warehousing, though the same principles apply when evaluating plant-attached operations.

Common Justification Considerations

Before we jump into the numbers, the following is a list of common justification factors:

• Smaller building footprint (great for new builds, not always applicable for existing)
• Direct & Indirect Labor Savings (of course… we’ll get to this one)
• Energy savings (icing on the cake, but rarely CAUSE for investment)
• Tax advantages (equipment having faster depreciation schedule vs. buildings)
• Optimized worker ergonomics (oftentimes achievable through other means)
• Reduced product damage (rarely cause for investment)
• Control of downtime (yes and no…)
• Increased worker safety (oftentimes achievable through other means)
• Improved inventory accuracy (is conventional really so bad?)
• Eliminate physical inventory counting (this is a process question)
• Improved order accuracy (oftentimes achievable through other means)
• Maximize order fulfillment rate (some days yes, some days no)
• FIFO inventory rotation (manual warehouses have this figured out)
• Control of “quarantined” product (manual warehouses have this figured out)
• Improved product integrity (starting to grasp at straws)
• Maximize service reputation (yes or no, depending on project success)

From this list, building footprint and labor are often the justification factors that CAUSE the investment in warehouse automation. The remaining items are icing on the cake.

Justifying Automation: Smaller Building Footprint

The advantage of smaller building footprint is rarely that an automated building costs less or that a smaller building has a reduced tax rate or requires less energy to heat and cool. Those savings are normally overwhelmed by the increased cost of automation. The advantage of a smaller building footprint is LOCATION, LOCATION, LOCATION. A smaller building can be closer to your customers, point of production, or employees. Location matters. Automation enables proximity to whatever matters.

The prime location could be a plant-attached warehouse where existing space is limited and the only direction to go is UP. A significant percentage of automated high-bay warehouses are built as plant-attached warehouses where land for conventional buildings was either not available or wished to be reserved to accommodate future production increases. Automation was the only design choice that enabled sufficient storage in the limited space available.

For new construction, the increased density offered by automation may allow building on land (close to producers or consumers) that would otherwise be too small for conventional designs. Of course, larger parcels may be available, but at such a cost as to make the additional investment in automation combined with a smaller lot size quite attractive.

When increasing capacities of existing buildings with automation, the sky is not always the limit. Limitations of existing buildings are things like: number of dock doors, truck lot sizing, refrigeration capacities, fire suppression systems, insurance, clear heights, floor condition and capacity, and numerous other factors. However, there are conditions where automating existing warehouse operations make good sense, and conditions when new automated facilities without land constraints make good sense. That’s up next…

Justifying Automation: Labor Savings

Labor is expended moving goods: unloading, receiving, transporting, storing, retrieving, picking, staging, and loading. Labor is not expended when goods are sitting on the shelf. A warehouse that is filled and emptied one time per year will have a difficult time justifying automation. There aren’t enough activity-based savings.

As a general rule-of-thumb, for a typical pallet-handling warehouse that is NOT plant attached, automation makes good sense when turning the inventory at least 12 times per year. Applications where the inventory is only turning 8 times per year may be marginal in terms of justifying automation based on labor savings (though other factors may be in play which compensate for the reduced activity).

Now that we’ve given an answer, let’s look at how we arrived at the result. The assumption in this scenario is that we’re justifying automation for a stand-alone warehouse (not plant-attached) with no labor savings to be had eliminating activities such as: loading on a truck at point of production, transport to the warehouse, and unloading at the warehouse. Adding plant-attached warehousing capacity has a different set of considerations such as: space available, desire to be warehouse owner-operator, sufficient volume to justify investment, contract with 3rd party, etc.

After the pallet has been unloaded off the truck, received, and sitting on the dock ready for put-away, an operator will put away 12-14 pallets per hour on AVERAGE. This isn’t just one hour of measured work, this is a full work week that includes breaks, start and end of shift activities, the normal ebb and flow of activity, and all the other things that are part of being a lift-truck operator.

We are also working on the assumption that unloading pallets off the truck and receiving processes are similar whether or not the warehouse is automated. Same for loading and shipping processes. We’ll also assume that overhead to manage operations and administration time for meetings is equivalent whether automated or not. Reasonable assumptions, though individual results may vary.

The following is a table that illustrates varying levels of activity (turn rates) and resultant labor savings that can be used to help justify automation. It should be noted that labor savings alone will NOT justify significant levels of automation. However, if labor costs continue to rise (rising wages to attract employees that otherwise will work elsewhere) or factors such as more desirable locations enabled by the smaller footprint of automation, the business case for automation continues to improve.

The financial whiz kids will not be impressed. This table (for the sake of simplicity and the fact that this information is FREE) ignores things like: NPV, IRR, inflation, etc.

In the example above, this warehouse does NOT generate significant labor savings over 3 or 5 year time horizons in low and medium turn environments. However, labor savings over 7 years and in higher turn environments is significant. A basic high-bay automated pallet-handling warehouse that stores between 25,000 and 50,000 pallet positions will run some $650 to $850 per pallet position for the racking, pallet-handling automation equipment, software, and engineering, excluding building related costs.

Add in other factors, including some of the icing-on-the-cake items, and a real business case begins to emerge to justify an investment in automation. If labor increases by 5% per year for the next few years, the business case for medium and fast turn applications looks even better. Factor in the right location, and automation is a compelling option.

As can be seen in the above table, all else being equal, only a few dollars more per hour on labor costs and automation becomes justifiable quickly from a labor savings perspective.

If there is an adequate supply of labor in a given market (and labor markets are just as local as the proverbial real-estate market), justifying warehouse automation in a lower-turn operation based on labor alone will be a difficult trick to pull off.

Of course, there is significant labor associated with case-picking or order-picking in a warehouse. There are an array of technology solutions that solve (or attempt to solve) the bespoke requirements of case-pick and order fulfillment operations. As with justifying a pallet handling warehouse, the level of activity will dictate labor savings and justification potential.

If the opportunity is going from off-site warehousing to plant-attached warehousing, there are significant savings to be garnered from truck loading, transportation, and truck unloading. In those cases, the activity-based savings are dramatic. That said, not every company wishes to make warehousing a core-competency, or has the space, scale, or ability. Off-site and/or 3rd party is a perfectly valid option with its own set of business drivers.

Justifying Automation: P/E Multiples

Understanding that 7- and 10-year investment horizons don’t always satisfy Wall Street, we can take a different perspective when justifying automation. A common financial metric that underlies stock prices for publicly traded companies and company valuation (especially for companies that may be acquired in the future) is the Price Earnings Multiple (P/E Multiple). The Price is the total value of the company. Earnings is profit. A higher multiple reflects a more valuable company (stock price or company valuation). *** Contact your financial advisor for investment advice! ***

Value (price) is a subjective measure based on animal spirits, mojo, and which way the wind blows. Earnings are supposedly objective. If earnings are expected to grow, the company is more valuable. If earnings are expected to shrink, the company is less valuable. ?The P/E multiple for a stable and growing company (we’re not talking about Silicon Valley Tech Unicorns here) is generally in the range of 12 to 20. For comparison, the P/E Multiple of the S&P 500 ranges between 15 and 20 depending on what side of the bed the global economy got up on that day.

We’ll flesh out an example. Let’s say your company has $66 million in earnings and is projecting moderate growth and you’ve got a fairly benign P/E multiple of 15. That means the company is “worth” $1 billion (on the stock market or in an acquisition). In this example, the company makes an investment in automation that results in annual savings (a.k.a. earnings increase) of $1.5 million on that typical medium turn warehouse of average size (see tables above). Those additional earnings (cost savings) get multiplied by 15 for the “valuation” of the company (stock market price or sale price).

That means $1.5 million additional earnings represents $22.5 million in terms of additional company value. What that means is a 25,000 pallet position automated warehouse that cost $14 million more to build than a conventional warehouse adds significantly more value to your company at the end of the first year of operation (when earnings are realized) than the additional cost to build automated in the first place.

Does it reflect well on your Earnings during the 24 months it took to build, start, and stabilize the operation of an automated warehouse? Heck no. If you need to make Wall Street happy every quarter, it’s a tough sell. If you can tell Wall Street to be patient for a few years (Amazon provides a reasonable case in point here if you recall years of losses while they built an order fulfillment juggernaut), the increased earnings provided by automation will result in a substantially more valuable business. ?

Justifying Automation: Time Horizons

As the saying goes, the difference between a poor investment and a good investment is 10 years. Investments in automation are frequently judged against a 3-year payback benchmark (or less). Companies often evaluate an investment in automation using the same justification metrics used to decide whether to purchase a new printer for the office. Warehouse automation (whether in-house or 3rd party) should be viewed through the same lens as investing in the core business. It is an investment in equipment and systems that enables your business to service its customers.

Whatever type of warehouse you build, whether conventional or automated, you surely plan to operate more than 3 years. Yes, the business requirements may change, but if you know the fundamentals of your business, a smart design will be sustainable through change. If we only planned around 3-year horizons we’d all be living, working, and warehousing in tents. We build structures and amortize them over decades. The equipment, systems, and processes inside those structures should be designed around similar timeframes.?

Before you get started

The first step of any automation project is taking a hard look at your process: a poor process done faster with automation is still a bad process. Optimize the process, then apply automation. Automation is not a substitute for poorly managed operations. Every company needs to learn how to apply technology in their own operations, with their own people, systems, processes, and customer needs.

We’ve only just started the journey toward widespread adoption of advanced automation. If you’ve been reluctant to adapt, then just get started. Innovation doesn’t happen in an instant. Companies and individuals that adapt will survive and grow. If you need help along the way, then Find an Expert!?