Challenges of changing the fixed to variable cost structure - fulfillment

There comes a point in almost every business when, within the operating model, the potential for growth is exhausted. The owner is then faced with a choice: maintain sales levels and watch customers slowly flee to the competition, or take operations to the next, higher level. It is the decision to scale further that is the moment when it is worth considering an alternative to expanding in-house logistics in the form of outsourcing operations to a professional fulfilment services company.

Potential of the market for fulfilment services

The first major study of this market was conducted in 2020 by the Institute of Logistics and Warehousing on behalf of GS1 and was published in the report 'Fulfilment in e-commerce'. On their basis, it is possible to estimate the potential of the market for fulfilment services and determine the group of potential customers for the offer of logistics operators.

The report indicates that more than 40% of e-commerce shops shipped more than 500 parcels per month during the period studied, while 70% of them have an assortment of more than 500 stock indexes. At the same time - despite the fact that most of the companies surveyed declared that they had their own warehouse space - more than 70% of them also indicated that they the high seasonality of the business, affecting the liquidity of operations.

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Author: Łukasiewicz Research Network - Institute of Logistics and Warehousing commissioned by GS1 Poland under

under the substantive supervision of Dr. Arkadiusz Kawa, source: https://gs1pl.org/app/uploads/2022/02/Raport_fulfilment_v3.pdf

The survey also included shops already using logistics operators and Nearly 98% of respondents rated their satisfaction with their cooperation with the fulfilment provider as 4 or 5 on a five-point scale.

Among the most frequently cited benefits of working with a fulfilment operator are:

• time saving
• increasing the quality of logistics services
• convenience
• greater development opportunities [1] .

However, the relatively high potential and high satisfaction of e-tailers already using operator services correlates rather poorly with the migration of e-business owners from self-storage to fulfilment warehouses. It is true that the e-commerce boom associated with pandemic restrictions in traditional trade has clearly stimulated interest in this type of service, but it is still difficult to speak of a scale comparable with Western European countries.

Reasons for this include:

• the still relatively low level of awareness of fulfillment among e-tailers

• lack of confidence in this type of service, resulting indirectly from a lack of awareness of the
• lack of meticulous analysis of logistics costs in the company
• the impossibility of comparing own costs to the potential costs of operations in a fulfillment centre on a public basis

Corporate logistics costs

Looked at from the strict calculation side, practically all costs in a company are of a variable nature (perhaps apart from the subscription for ICT services or the rent for the warehouse expressed in PLN). In e-commerce logistics, however, it is customary to assume a division between fixed costs (independent of the number of orders) and variable costs (strictly related to the number of operations).

Fixed costs in e-commerce logistics are typically:

• salaries of persons with employment contracts
• costs of employment services (human resources, training, health and safety)
• the cost of the rent for the warehouse space including service charges
• costs of utilities (energy, water, heating, internet) - as a rule these may be time-varying costs, while they are only marginally related to the number of orders
• insurance and protection costs

Variable costs in e-commerce logistics include:

• packaging costs
• costs of fillers, adhesive tapes, labels and print-outs
• courier and return shipping costs
• wage costs for temporary workers/agencies
• the cost of employee bonuses, insofar as they are based on the number of orders realised.

Product storage costs

Among the significant costs faced by e-commerce entrepreneurs are the expenses associated with product storage. Keeping stock in the warehouse is not only the cost of the capital frozen in the goods, but also to a large extent the cost of their ongoing storage.

How do you determine the cost of storage? The simplest calculation, based on a fairly simplistic mathematical average, consists of determining the total monthly costs of the warehouse (rents, utilities, insurance) and the average daily stock in pieces.

If, for example, the fixed costs of our logistics centre are PLN 60 000 and the average daily stock is 10 000 items, the average daily storage cost per item is PLN 0.20.

It is much more difficult to calculate a weighted cost that depends on the space occupied by specific products in the warehouse. Here, the most authoritative indication would be to calculate the volume of products on the one hand, and the nominal available volume in the warehouse and bin conversion on the other.

Example for weighted cost of storage of goods:

• storage capacity: 2500 shelves of 0.15 m3 each = 375 m3
• cost of the warehouse: PLN 60,000
• cost per m3 per day: PLN 5.25 (average 30.5 days per month)
• cost of 1 dm3 per day: approx. 1 penny

In a nutshell, this means that when the warehouse is fully stocked, it costs one penny per day to store each unit of approximately one litre. This price seems extremely attractive, but the problem arises when stocking is incomplete. When the shelves are half full, the cost doubles, which means that each product stored for, say, 3 months reduces our margin by less than PLN 2.

It is worth noting that the larger the volume of the product stored, the higher the storage cost. For example, an office chair in a 40/60/60 cm carton gives a volume of 144 dm3, which means a daily storage cost of PLN 1.44-2.88. On a scale of month, this means a monthly storage cost for a stock of 10 chairs in the range of PLN 430-860.

Seasonality of stock in the warehouse

From the point of view of liquidity and the matching of the cost side of the business with revenue, in terms of storage The biggest challenge is the high seasonality of stocks.

If the business is based on a reasonably constant and predictable number of orders and deliveries are made on a national or EU-wide basis - then this factor is of relatively little importance and storage costs are reasonably predictable and easily quantifiable.

However, for a business with a very large seasonal variation in turnover, and for a business based on the cumulative import of goods from the Far East, for example, the problem is much more serious. The cost of the warehouse is fairly fixed, and its space has to be adapted to receive and process a large volume of goods in a short period of time. In the case of imports - this is compounded by the so-called deadstock, i.e. the period in which the goods have already entered the warehouse and the sales season has not yet started. As a result of the seasonal structure of sales, we are often faced with a warehouse that is half or even less than half full for ¾ of the year, and just before the peak trading period, its occupancy often exceeds 100% of its nominal capacity.

This situation has a huge impact on the profitability of the business. In the 'lean' period, we have an extremely high burden of each item sold with a disproportionately high cost of storage, while in the prosperous period we flail about with a lack of free space. This type of business model can only be sensibly balanced and profitability calculated on an annual basis, and this is provided that the 'fat' period provides an adequate margin to cover the inflated off-season costs.

Personnel costs in logistics

Similarly, accounting for logistics costs in e-commerce arising from employment costs is a major challenge.

A team of permanent warehouse staff has a certain capacity per person. In the short term, this can be increased with overtime or simply by temporarily speeding up operations, but a team of 3 or 4 people will not be able to process, for example, 700-800 orders per day for a fortnight in a row. At the same time, in the off-season, with 400-500 orders per day, there is an unused working potential, which of course costs money to maintain.

One way to deal with this challenge is to use seasonal workers or temporary work agencies. However, this solution is not ideal due to the following factors:

• if the company lacks an easy-to-use warehouse system and the products on the shelves are taken partly "from the memory" of the warehouseman - -. deploying a new employee even for a short time will cost a lot
• even if you have a warehouse system and clear racking and shelving markings, you still have to reckon with a period of reduced efficiency for the new employee at the outset and the cost of maintaining additional licences for the WMS and the equipment used to operate it

As is the case with warehousing costs, personnel costs can also negatively affect the economic balance sheet of an e-commerce business if the business owner is not able to link and match them to revenue within certain time frames.

External costs

Virtually everywhere in business, the 'big can do more' principle is at work. In e-commerce, this translates into both unit packaging prices and shipping costs when it comes to external costs.

The most difficult challenge is faced by those who are just starting out or growing rapidly. Lack of historical data or low prior volumes make it impossible to obtain attractive prices for cartons or courier services, which in turn negatively affects the costing of the overall business.

Own costs vs. fulfilment costs

The idea behind fulfilment services in terms of cost is to make the largest possible share of variable costs in the total cost of e-commerce logistics operations. This applies to both warehousing and order fulfilment costs.

Normally, the price lists of logistics operators provide for daily charges per storage unit (e.g. per shelf per day, per pallet per day). Sometimes this is in the form of charges per cubic metre per month, but this conversion rate is very uncommon in Poland.

With contractually agreed averaged stock levels, the logistics operator guarantees us dynamic charging of storage costs depending on the actual amount of goods in stock. If, for example, we have an average of 10,000 units of similar products in stock per day and we pay X PLN per month for them, and a shipment arrives for the season that doubles the stock, but it sells out in 14 days - this means that after just 2 weeks our daily storage cost returns to a relatively constant level. In an in-house warehouse, such an effect is impossible to achieve due to the fixed nature of the facility's maintenance costs.

The situation with order processing costs is even more interesting. These are directly linked to the number of operations and usually, with fairly homogeneous processes (fairly repetitive orders), the invoice item 'order processing' is calculated according to the formula X*Y, where X is the price for order processing and Y is the number of orders in a given month. This is the best possible option to link revenue to costs, as shown below.

more orders = more sales = more cost per invoice

fewer orders = fewer sales = lower cost per invoice from the fulfillment operator

When is it worth opting for fulfillment?

The choice of an external logistics operator instead of an in-house warehouse is attractive and makes good business sense especially in the cases described above: a large spread between the smallest and largest warehouse fill rates and large differences between in-season and out-of-season order volumes and large order spikes over short periods of time.

However, arguments related to internal logistics costs are not everything. For example, in As part of the InPost Fulfillment service, customers can benefit from attractive packaging prices often unattainable for individual, smaller recipients. They also have access to very attractive prices for parcels as part of the Paczkomat® and Courier InPost services. All this is thanks to the synergy of shipping and logistics services provided by InPost.

However, in the economic calculation of an e-commerce business, fixed and variable costs directly related to logistics are not everything. One should not forget the high initial costs of setting up an in-house warehouse, training costs, maintaining quality or the potential costs of scaling up operations. Using InPost Fulfillment services, these costs are practically negligible thanks to the zero barrier to entry (systems and infrastructure are provided by the operator), and as the scale of operations increases, we can count on price optimisation, which can clearly translate into profitability of e-commerce sales.