Thought Leadership
A guide to justifying the ROI on a WMS
- Category: Warehouse Management
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Recognising the need for a WMS is a straightforward exercise for many warehouse managers. Inaccurate inventories 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, in order to provide an accurate basis for justification.
Step 1: Define the Problem Areas
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
5. Visibility
The above key areas help to form the building blocks of justifying a WMS . The absolute 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 of 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
Step 2: Estimate the Internal Costs or Lost Savings
Once warehousing problems have been documented, the next step is to estimate the costs associated with each. This step is critical to understanding the severity of any problems:
How to Estimate the Internal Costs or Lost Savings
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.
Examples of typical costs are listed in sample ROI table. Having completed a quick benchmarking exercise against the key industry standards you should then be able to determine where your DC is currently at and what the potential improvements will be if you arrive at the key goal.
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 revenue on warehouse labour. A year after implementation of their WMS, labour costs had fallen nearly a full percent (a savings of approximately R450,000), 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 just-in-time requirements have forced manufacturers and distributors 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 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.
What is the magnitude of savings that should be expected?
Typical improvements and savings that can be achieved with a successful implementation of a WMS are along the lines of:
- Labour Utilisation 10-45%
- Inventory Reduction 5-40%
- Floor Space Utilisation 10-40%
- Maintenance 0-10%
- Shrinkage 50-99+%
- Rolling Stock 10-20%
- Increase Shipping Accuracy to 99% +
- Increase Data Entry Accuracy to 99% +
Step 3: What will a WMS cost my organisation?
At this point in the process, it will be reasonably clear how much money and time a good WMS product 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), computer 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.
The 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 R100 today or R120 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 R100. If you could earn more than 20% you would accept the R100 today because your earnings after one year would be greater than the R120 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 R3,000,000 today for a WMS that will provide estimated savings of R1,000,000 in the first year and R1,500,000 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 that R1,000,000 and R1,500,000 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 (R3,000,000).
Assume your management requires a return of 15% on all capital investments. At 15%, the first year’s savings of R1,000,000 is worth R869,600 present day. Present day value R1,500,000 savings for years two through four is R1,113,415, R986,250, and R857,700, respectively. Add the total savings in today’s dollars and you get R3,847,700. Because the total saving in today’s money (R3,847,700) is greater than the total price of the WMS (R3,000,000), the investment can be justified.
Why not calculate your Labour Management ROI right now? Use our online ROI Tool.