Part 1 of 2: The Price You Pay for Mistakes and the Importance of Good Metrics

The way you manage your warehouse can make or break the future success of your company.  A warehouse run without a clear-cut, streamlined and efficient process will undoubtedly require countless hours of time spent figuring out and fixing mistakes, and incurring unnecessary costs along the way. The foundation of any business is made up of certain principles. These would include: running an organized operation, providing a level of service that allows you to attract and keep good customers, offering a competitive price while also making a profit, and keeping overhead costs low. While adhering to these ideas is important for some, it is crucial for warehouse and distribution companies. In the first part of our series on: A 360 Degree View of Successful Warehouse Management, we will take a look at some of the common mistakes made by distributors, as well as how you can implement the right metrics to help you improve your process.

The Price You Pay for Mistakes

The true cost of mistakes isn’t set in stone. It not only depends on what kind of error occurred, but also how soon it is caught and fixed. For example, if your shipping department notices that the wrong item is set to be shipped to a customer before it leaves your warehouse it is substantially cheaper than if the wrong item is found by the customer upon receipt. Furthermore, there are both hard and soft costs involved in the mistake making process. While you can see and quantify some costs right away, others may only be apparent over time. These include:

Hard Costs  

• The cost of shipping (both in getting the wrong item back from the customer, and in re-sending the right one overnight via an expedited and therefore more expensive method).
• The amount you have to pay employees to do and re-do the work (from picking, packing and shipping the wrong product to processing the item back in, putting it away, and picking, packing and shipping out the correct item).
• The costs incurred by your accounting and customer service departments (invoicing and crediting the item, not to mention spending time corresponding with the unhappy customer).
• The costs you may incur to keep the customer (including reimbursing the item, or providing a more expensive one free of charge).
• The cost of purchasing the item from a secondary distributor because you don’t have it stock and have inadvertently promised it to a customer.

Soft Costs

• Potential lost sale of the incorrect item while in transit to and from someone who never wanted it.
• Lower customer satisfaction levels resulting in reduced customer retention.
• A declining reputation making it less likely that you will keep customers and/or be referred new business.

Increased overhead and the loss of customer loyalty can put your company at a huge disadvantage. The standard hard cost of each shipping error can run between $100 and $200 dollars. Even if your warehouse is running at 95% efficiency you could be losing tens of thousands of dollars annually. For example, let’s say you ship 100 items out each day, and are open for business 220 days a year. By this estimate you’d be shipping roughly 22,000 items in a twelve month period. If 5% are inaccurate and each costs you $150, you can be out upwards of $165,000 each year! Suddenly a 95% success rate doesn’t look like an A.

The soft costs of customer loyalty can be much more difficult to measure, however Dr. Paul Wang from Northwestern University was able to create a specialized method. Using a concept called the Customer Lifetime Value (CLV)1  he measures revenue, margin, and customer retention rates in order to come up with the current value a customer would provide in a year. While the details of his mathematics are enough for a whole other article – we can say that the result of lost customers can enter the hundreds of thousands if not millions of dollars over time.

The third price you pay is in acquiring new customers to replace the ones you lost. This cost can be identified by noting how much was spent on marketing efforts in any given time period and dividing that by the number of new customers attracted. In general, many organizations spend between $500 and $3000 per new customer. As you can imagine, it is much cheaper to keep current customers than to attract new ones.

The Importance of Good Metrics

Implementing new procedures and metrics that allow you to reduce and/or eliminate errors will substantially improve your process. A metric is a standard set in place by which success and/or improvements can be measured. These will enable you to gain insight into the inner workings of your operation in order to improve your warehouse management process.

To come up with the appropriate metrics for your warehouse it is important to:

1. Study your organization.
2. Set appropriate and realistic goals.
3. Provide the resources necessary to meet your goals.
4. Create a clear method for calculating the measurements, identifying the source data and creating the necessary reporting.
5. Ensure that everyone in your organization understands the new process and is on the same page. If you are able to give your staff the access they need to the metrics; they will be more effective at meeting the goals set forth.

So then, how do you identify the appropriate data? Most warehouses will want to account for receiving and put away, as well as the pick, pack and ship processes. However depending on your specific vertical market there are likely many other processes to measure. For example, if you sell items that require measuring and cutting, such as in carpet, fabric, wire, etc., you’ll want to and track items in-stock, measured as well as account for scrap management, etc.

While it is up to you to determine the specific measurements that apply to your warehouse, some common ones may include:

• Shipping errors accrued by day/week/month
• Freight charges
• Inventory accuracy
• Annual product turns 
• Items picked per hour/individual/or team
• Time to pick/put away
• Time spent problem solving
• Etc.

Once you are able to determine the appropriate measurements for each of the applicable processes within your warehouse you need to figure out how to report it. We’d encourage you to implement and utilize reporting that is as close to real-time as possible. While monthly and yearly reporting can be helpful – it won’t allow you correct mistakes and make improvements in a cost effective manner. Access to hourly and/or daily reports will give your managers and staff the ability to consistently make the best use of their time and capabilities.

Putting Your Best Foot Forward

Taking the time to build and maintain a high-quality process is sure to benefit your company over time. The data yielded by the metrics you put in place will help you institute a new set of processes that seek to reduce or even better, eliminate common errors. While this can take some extra work up front – you’re sure to reap the rewards of an organized and cost-efficient warehouse, more return customers, and increased referrals over time.

Stay tuned part 2 of this series where we’ll cover the value of EDI, and how you can maintain your optimized warehouse.

1 http://crmguru.custhelp.com/app/answers/detail/a_id/1381/~/a-primer%3A-here's-how-to-calculate-customer-lifetime-value