New technology will add to your capital equipment investment and other expenses. But, will it reduce your total labor expense? If it does your total warehouse operating cost may be lower. If the new technology provides additional capacity or reduces your errors, it may increase the number of line items successfully shipped. To determine whether or not new technology is a good investment, calculate your cost of successfully filling a line item on an outgoing order with and without the potential improvement. We refer to this as the Total Warehouse Cost Index or “TWCI”.
The TWCI is calculated with the formula:
Total Warehouse Operating Cost per Month ÷ Line Items Successfully Shipped per Month
Let’s look at an example:
Currently, a warehouse is filling 10,000 line items per month with an average of 400 errors. The total warehouse operating cost is $62,380 per month:
$62,380 ÷ (10,000 – 400) = $6.50
The company is anticipating a 30% increase in business over the next year. This means that 13,000 line items will be shipped. Using their current system, the company will have to add two additional warehouse people ($4,800 additional labor expense) and an additional $1,000 in other expenses (it is assumed that the error rate will remain the same). The projected TWCI at the end of the year will be reduced to $5.46 per line item (it is assumed that errors will also increase by 30% to 520 per month):
($62,380 + $4,800 + $1,000) ÷ (13,000 – 520) = $5.46
This company finds that implementing a WMS system will increase depreciation and other expenses by $5,000 per month. At the same time, it promises to reduce labor expense by $1,100 per month (even though more line items will be shipped). The company will still incur other additional expenses of $1,000. This means that total warehouse operating expenses will increase by $4,900 ($5,000 – $1,100 + $1,000). Other companies that previously implemented this WMS system report a line item picking error rate of 2% and the capability to process up to 20,000 line items per month with the configuration this firm is implementing. As a result, there is plenty of capacity to handle the distributor’s planned expansion. The projected TWCI at the end of the year will be $5.28 per line item:
(62,380 + $5,000 – $1,100 + $1,000) ÷ (13,000 – 260) = $5.28
In this case, the implementation of automation will reduce overall costs (if indeed labor and errors are reduced). But what if there were no labor savings of $1,100 and the error rate remained 4%? The TWCI would then be:
(62,380 + $5,000 + $1,000) ÷ (13,000 – 520) = $5.48
In this last scenario, the company’s cost of filling an order will actually be higher after implementing the new technology ($5.48 after implementing technology versus $5.46 before implementing technology). It is very important not only to calculate the TWCI before and after the implementation of new technology but verify that any claims of savings are well documented and you can see them proven at other installations of the system!