Logistics, Warehousing & Distribution

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Site Selection Portfolios

29 Feb, 2008

By: Jane Mather, Ph.D.
Optimal Today but What About Tomorrow?

In the world of site selection, companies spend incredible amounts of energy and analysis to select the right location. But how often do they go back and review their portfolios to make sure that they continue to work for their business. For most companies, not very often. Perhaps a merger, cost reduction initiative or major lease expiration prompts a portfolio review. But most often, companies rely on their existing real estate portfolios without considering whether their portfolios continue to support their business.

 
Suboptimal portfolios can result from many situations. Often real estate portfolios are created through individual transactions that aren’t part of an overall strategy. Mergers and acquisitions can result in redundant and mismatched locations. Finally, times change – even if the portfolio was optimal last year, it may not be optimal this year. The same factors that were so important in the original location selection - customer and supplier locations; labor, real estate, energy and transportation costs; and the business and political environment - can all change. 
 
When revaluating a portfolio, decision makers must look beyond today’s business conditions to what might happen in the future. Certainly, it’s not possible to forecast the future perfectly -“a good forecaster is not smarter than everyone else, he merely has his ignorance better organized” - but that doesn’t mean planners can ignore the possibilities.

Manufacturing and distribution locations

Portfolio rationalization and reoptimization are more common for manufacturing and distribution locations than for knowledge worker locations such as call centers, back-office operations, research and development locations, and information technology centers. According to MIT Professor David Simchi-Levi, leading companies reoptimize their manufacturing and distribution locations every few years. Changing business conditions have a dramatic impact on costs and tools to evaluate and respond to these changes are more readily available for supply chain optimization than for knowledge workers locations.
 
Over the last few years, shifting customer and supplier markets, as well as the continued search for lower labor costs, have driven many portfolio changes. Nokia’s vice president for workplace resources, Mark Tamburro, sees the trend continuing: Nokia’s portfolio is expanding into Africa and the Middle East in response to increasing demand at the same time as Nokia continues to expand in China. Greater attention to risk management and major retailers’ demands for “higher service levels,” primarily faster delivery times, have also led to portfolio changes.
 
Energy costs

Going forward, higher energy and transportation costs and carbon emission regulations are likely to motivate additional changes in manufacturing and distribution networks. Some observers are seeing few effects of higher transport costs on distribution networks, in part because distribution networks are already optimized to reduce transportation costs, according to Mike Peters of ProLogis, a leading provider of distribution facilities.
 
On the other hand, Professor Simchi-Levi is seeing more companies reoptimize their networks in response to higher transportation costs, more demanding service level requirements and greater attention to risk management. Companies are also shifting to more flexible production and distribution networks to improve responsiveness, reduce costs, and avoid facility relocations in the future. For both the long-term location decisions and the short-term production decisions, Professor Simchi-Levi sees more companies using supply chain optimization software, with short-term production sourcing decisions being reevaluated quarterly, or even monthly.
 
Professor Simchi-Levi is also seeing a major impact from carbon emission regulations on manufacturing and distribution locations. The importance is illustrated by the size of the market for carbon emissions permits in Europe, which is estimated at between $25 and $40 billion for 2007. In anticipation of similar carbon emission legislation in the U.S., leading U.S. companies are already starting to consider these costs in their network optimization.
 
For data centers, where energy costs are a major cost component, current energy costs and the anticipation of further increases are also affecting location decisions. With its continuing shift from carbon-based energy sources to wind and solar power, Google is selecting locations that are more suitable for these renewable energy sources.
 
Future energy costs should also be considered when setting new construction standards for the portfolio. According to the energy and environmental organization, Rocky Mountain Institute, energy efficient construction alternatives are often overlooked, even though they could be more cost effective than traditional approaches. When future energy costs are considered, the importance of adopting more energy efficient construction alternatives is much more evident. The best time to implement energy-efficient technologies is in the beginning; once built, there’s less opportunity to improve energy efficiency and reduce costs.
 
Labor costs and skills for knowledge workers

For knowledge worker locations, such as call centers, back-office locations, and technology centers, portfolio evaluations often follow years of “portfolio intransigence.” The examples cited here are notable for the fact that real estate professionals eventually took the time and effort to evaluate their portfolios and to convince stakeholders to change the existing structure.
 
For one Fortune 100 financial services firm, 10 years of acquisitions had created a portfolio filled with a patchwork of operations spread across nine locations. According to Mark Seely of CBRE’s Labor Analytics Group (LAG), the portfolio showed a mismatch between skills levels and the activities conducted in each location. The team classified work activities into five groups, each with different skill requirements, ranging from basic customer services to financial analysts making more than $100,000 per year. Then they identified the labor costs for each group in the nine locations and found opportunities for significant improvements. Basic customer activities could be shifted from a high-cost Chicago suburb, with labor costs of $16 per hour, to the company’s rural locations where labor costs for basic customer service activities where $10 per hour. At the same, financial analyst positions could be shifted to the Chicago location where there was greater availability than in rural locations. By considering the different skill sets, this company was able to reduce total work force costs by $25 million.
 
Insufficient attention to worker skill sets has also led to problems in some offshoring decisions, according to Tim Nitti of KLG, a location strategy consulting firm. Many companies started their offshoring initiatives by relocating activities requiring basic skill sets. Once they saw those activities were being sourced effectively, they assumed that these locations would also work for other activities. For some software activities, offshoring wasn’t the answer. The work required closer coordination, time zone differences made coordination difficult, and employers found that wage rates were higher than publicized and increasing. Now, as some companies try to relocate these activities back to the U.S., or to more appropriate locations, they are facing additional costs due to India’s labor regulations regarding closing operations.
 
Changing employee skill requirements

With changing technology impacting skill requirements, some locations may no longer be appropriate. For example, consider skill requirements at call centers, or as they are now being referred to, contact centers, one more indication of the impact of changing technology. While basic skills may be sufficient in the current market, they may not be sufficient in the future. With new technology, customers can answer easy questions and complete easy tasks on the company web-site and through automated telephone systems. With the basic activities completed automatically, the tough questions and tasks are left for customer service representatives, who will need better skills as a result.
 
Many call centers are already seeing a need for more skilled workers. For example, financial services staff need to be able to answer questions about their own products and cross sell other services. In its Global Contact Centre Benchmarking Report, Dimension Data found that 60 percent of its sample had upskilled staff to work across “multiple query types” and 53 percent are upskilling to work across “multiple channels.”
 
At the same time, better technology and software can help customer service representatives answer complex questions more easily, noted Mark Seely of CBRE’s Labor Analytics Group. With less need for high-skilled workers, one financial service company could shift more of its operations to smaller operations in rural areas with lower costs and lower turnover.  
 
Demographic trends

While these labor cost differentials have been motivating relocations for years, many companies are only now considering how demographic trends may affect future costs. According to Tim Nitti, five years ago it was rare that a company was willing to consider future demographic trends. Now, with tighter labor markets, companies are facing higher labor costs, higher turnover and increasing difficulty filling jobs. Finally, they are starting to pay more attention to changing demographics and how it will impact future costs and labor availability.
 
As Fidelity Investments reviewed demographic trends, they saw that the continuing population shift from the northeast and plains states to the south and west would increase labor costs and limit labor availability in its primary Boston-area locations. In the past, Fidelity’s competitive advantage had enabled them to pay higher wages than competitors, but looking forward, they realized that future trends could lead to problems.
 
But change wasn’t easy. A joint real estate and human resources team needed to complete a major communications initiative to warn senior management and business units and overcome cultural intransigence, the “800-pound gorilla,” according to Sarah Abrams, president of Fidelity Real Estate Company.
 
Increasing labor costs and turnover in saturated labor markets provide another example of the need to review portfolio composition. For years, companies have been relocating activities from higher cost locations to lower cost locations, especially in the south. As this trend continued, relocations became concentrated in high profile locations such as Phoenix, Sioux Falls and San Antonio. Labor costs and turnover increased, limiting the attractiveness of these locations. Many companies are now considering “labor market longevity” and relocating to rural locations where the potential for saturation is more obvious.
 
More portfolio evaluation for knowledge worker locations?

While network optimization and reviews are common for manufacturing and distribution networks, portfolio managers responsible for major knowledge worker locations - call centers, back-office operations, research and development locations, and information technology centers - spend relatively little time reevaluating and reoptimizing their portfolios. In part, they don’t have the time to evaluate their portfolios on a regular basis. When a new site is needed, you have to do the analysis. Once facilities are completed, there isn’t a pressing need to evaluate the portfolio. And admittedly, the cost of changing locations often overwhelms the benefits. But when there’s sufficient business change, the benefits - millions of dollars in labor and real estate cost savings - can easily offset the costs. And these dwarf the costs of time and data collection for evaluation.
 
Some managers claim they can’t reassess their portfolios until they’ve completed a comprehensive database system. But typically, the number of major knowledge worker locations, the ones that matter for this type of portfolio assessment, is relatively small and the data can be collected without a comprehensive database. Each year without a portfolio review is one more year of unnecessary costs.
 
On the other hand, evaluating a portfolio of properties can be complex and time consuming, it’s like a huge jigsaw puzzle. But, just as there are specialized techniques for network optimization for manufacturing and distribution activities, there are similar techniques for portfolio optimization for knowledge worker locations. With these techniques, the process is not only easier, but planners can often find tens of millions of dollars in additional costs savings.
 
Conclusion

In a constantly changing business environment, companies can’t afford to rely on their existing portfolios. As noted by Eric Hoffer, self-educated longshoreman and author, “In times of profound change, the learners inherit the earth, while the learned find themselves beautifully equipped to deal with a world that no longer exists.” And in business, profound change is everywhere. For real estate portfolio managers, if they don’t reevaluate their portfolios, they will find themselves with beautiful facilities for a world that no longer exists.

 

 

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