A guide to justifying the ROI on a WMS
Identifying and understanding the key drivers behind the ROI for a WMS can help you ensure you have the necessary information to ensure you can cost justify your decision, the payback period and the benefit
Step 1: Define the Problem Areas
Step 2: Estimate the Internal Costs or Lost Savings
What savings should be expected by implementing a WMS?
Step 3: What will a WMS cost my organisation?
Recognising the need for a WMS is a straightforward exercise for many warehouse managers. Inaccurate inventories, customer service issues and pressures to continually reduce costs make the investment decision almost intuitive. Investments, however, are rarely made based on intuition. Fortunately, the benefits of a WMS can be identified and, to a great extent, quantified and this will provide an accurate basis for justification. Below we describe the core steps required to build out the justification:
There are many benefits that will be achieved when a WMS is implemented correctly. These benefits lie in the areas that cause the majority of efficiency problems in warehouses and include:
1. Inventory Accuracy and Carrying Costs
2. Labour Management
3. Facility and Distribution Resource Optimisation
4. Customer Service
The above key areas help to form the building blocks of justifying a WMS . The first thing that should be done is to clearly identify and document your key problem areas. Using the 5 headings above is a useful way to build out a matrix that helps to create a baseline for capturing your challenges and the key metrics that you will use to build out the justification.
There will usually be several key players involved in capturing, documenting and measuring these challenges and it is recommended that the advice of an experienced facilitator be leveraged to assist in clearly defining, measuring and creating a baseline issues list.
Generally the person responsible for managing the warehouse will be best placed to come up with a baseline list of challenges. However, to ensure that all problems have been identified, other stakeholders in the warehousing process should be asked for their input.
Common problems occurring under the various headings may include:
Inventory Accuracy and Carrying Cost - excess inventory, misplaced product, and mis-picks.
Labour Management - problems may include excessive time searching for product, inefficient pick paths, and no or limited pick rate and order fill performance.
Facility and Distribution Resource Optimisation – inefficient storage methods that lead to under utilised locations and excessive pick, travel and search time and can also lead to unnecessary and expensive building extensions
Customer Service - Problems often include ship errors and delayed shipments.
Visibility - Information management problems may include stock-outs, false stockouts, excessive inventory and unnecessary expensive resources
Once warehousing problems have been documented and benchmarked, the next step is to estimate the costs associated with each. This step is critical to understanding the severity of any problems:
A variety of equations and industry standards can be used to quickly estimate the costs with examples of typical costs being listed in simple ROI table.
Having completed a benchmarking exercise against the key industry standards you should then be able to determine how your DC is currently performing and what the potential improvements will be as you move from your current state to the industry standards and beyond.
Other specific cost savings examples include Labour utilisation and can be measured in a number of different ways. One common measurement is the cost of warehouse labour as a percentage of revenue. As an example, prior to the installation of a WMS, one SCJ customer spent close to 3% of company revenue on warehouse labour. A year after implementation of their WMS, labour costs had fallen nearly a full percent (a savings of approximately US$450,000), while their sales had increased by close to 30%. This is due to the fact that a WMS allows more to be done with fewer resources.
The desire to improve inventory accuracy is another prime reason to invest in a WMS. Inventory reduction and increased customer service expectations have forced manufacturers, wholesalers and retailers to re-think traditional inventory management philosophies. Accuracy levels exceeding 99% are generally required to achieve world-class service levels, and this must be achieved within a competitive cost and service structure. Unless inventory accuracy is above 99%, it is extremely difficult to reduce stock levels with any degree of confidence. The savings associated with the reduction of inventory levels may themselves justify investment in a WMS. Many companies have reported reducing inventory levels by as much as 30%. This level of reduction greatly affects carrying costs, which typically equate to 25% to 35% of the cost of inventory.
- Labour Utilisation 10-45%
- Inventory Reduction 5-40%
- Warehouse Utilisation 10-40%
- Picker productivity 10-50%
- Shrinkage 50-99+%
- Increase Shipping Accuracy to 99%
- Increase Supplier Conformance 99% +
- Customer Service 10-50%
- Increased Inventory Availability 10-50%
At this point in the process, it will be reasonably clear how much money and time the right WMS will be able to save. The next step is to determine how much will have to be spent to successfully implement the WMS.
Although vendors use various pricing models, the components of their pricing proposals usually fall into five categories. These are license fees, custom development (if applicable), server & infrastructure hardware, radio frequency hardware, and services such as design, implementation, training, testing and travel. Your internal costs to implement the system should also be included when defining the total cost of the implementation, as well as the cost of maintenance over the time period for which you are calculating the ROI .
Although the price of a solution is important, there are other important criteria that should be considered when selecting a vendor including track record, size, investment into R&D, financial stability and the level of trust and confidence between vendor and customer.
Using a NPV calculation compares the price of the WMS to the level of future savings that it will provide. One simple example of an NPV consideration is to consider whether you would rather have $100 today or $120 a year from today. NPV considers the time value of money.
To arrive at an answer in this example, you would have to decide how much interest could be earned in a year on the $100. If you could earn more than 20% you would accept the $100 today because your earnings after one year would be greater than the $120 you would otherwise receive.
To calculate the NPV on an investment in a WMS, several pieces of information are needed. First, determine the total cost of the system. Second, calculate the annual savings for at least the first four years after implementation.
Finally, determine the rate of return required by the company on capital investments. Let’s look at an example. Assume you spend $500,000 today for a WMS that will provide estimated savings of $250,000 in the first year and 200,000 in years two to four.
Remember, these are the savings you calculated in as part of the ROI exercise. Also remember, that the present day value of these savings is less than $250,000 and $200,000 respectively. Your objective in calculating the NPV is to determine the value of those annual savings today and compare it to present day’s cost.
Assume your management requires a return of 15% on all capital investments. Add the total savings in today’s dollars and assuming your performance can be improved by the necessary standards to meet the industry benchmarks, the investment can be justified.
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