“You say you want a revolution?”

Since the 1970s the process of globalisation has been driving the evolution of supply chains and even today is continuing to spur change. During the 70s and 80s manufacturing became international and this led retailers to compete on price, but by the 1990s consumers had started to take low prices for granted and so competition switched to providing the widest possible range of goods. Today, not only is globalisation still shaping supply chains, but e-commerce is pushing retailers to provide better and in particular faster service, .

E-commerce is now around 20 years old, but it is only recently that it has truly started to have a significant effect on changes in the market. The internet is now providing consumers with new methods of shopping and, as a result, it is changing expectations, with customers demanding not only shorter delivery times but greater convenience. Online shopping is putting ever greater pressure on the distribution system and now accounts for 20 pct of new leasing activity, when just a decade ago this same figure stood at 5 pct. Prologis hasexamined exactly how these forces are currently shaping the market and what the likely effects will be.

In a recent report entitled ‘E-Commerce, the Service Imperative & Essential Location Strategies’, Prologis Research identifies five types of logistics locations – two of which are close to the production-end of the chain,while the others are closer to the consumer-end.

The first type of location at the producer-end are supply locations, where raw materials and components are stocked for direct delivery to the manufacturer and hence this type of location is typically found near the factories. The second type of centre is for order consolidation where finished goods are prepared for export or for domestic shipment and, as a result, such centres are located between the manufacturers and transportation nodes.

The first type of location at the consumer-end are the import centres and centres for pan-regional distribution. Most commonly, such centres are found at ports or other such bottlenecks in international trade. Such centres can both serve local populations and act as deconsolidation points from which goods are shipped to other warehouses closer to the end-consumer. The centres such locationssupply also come in two types. There are the regional distribution centres, which are frequently built just outside large population centres and are the usual supplier for traditional brick-and-mortar stores, but will also often fulfil online orders and send goods directly to the consumer. Finally, there are retail centres themselves,which will hold a limited stock of goods and consumers must travel to these locations to purchase items.

Rebuilding the supply chain

The study concludes that investment in supply chains is set to jump, but this investment is likely to be concentrated at the consumption-end of the chain.

In the early 2000s when e-commerce was a relatively new phenomenon, the lion’s share of investment went into centralised locations, which allowed inventories to be pooled and delivery times to be balanced across large regions, but the system was slow and expensive. Now the investment is going into regional centres to keep inventories close to the end-consumer, who has now come to expect lightning fast deliveries. Moreover, additional return centres have had to be added to the network, which by also being kept close to the consumer minimise reverse costs and allow for returned goods to be recirculated back into the supply chain quickly.

Investment is also going into what Prologis Research terms the ‘Last Touch™’ network. Much of what this network comprises is often referred to as the Last Mile, but Prologis claims that this term is often a misnomer since it usually covers larger distances. Nevertheless, locations that are specifically used to supply direct to the end-consumer are at the receiving end of much of the new investment. They are most often urban sites developed within cities and sometimes older locations built when the availability of such sites was much greater. Such centres make it possible to provide same-day deliveries or supply goods on terms that are even shorter.

As a result of such changes, the logistics industry is moving from a centralised model to a chain with multiple steps where goods are unpacked from shipping containers to pallets, then from pallets to boxes, and then occasionally from boxes to individual goods that are then sent to the customer.

Bigger and smaller

As previously mentioned, much of this demand is concentrated within cities themselves where land for logistics purposes is at its most limited. This is leading to fast rising rents and high occupancy levels, with the situation unlikely to improve any time soon. E-commerce continues to grow at double-digit rates and the logistics industry is doubling in size every five to seven years. Prologis also notes that international trade is continuing to grow at prodigious speed and the researchers point to the increase in logistics sites around international ports such Chicago or those in the Netherlands.

Even though such a multi-site supply chain system might appear anexpensive proposition, extra costs are not hard to bear because logistics real estate still takes up a relatively small proportion of the overall coststructure, representing only 5 pct of supply costs and less than 1 pct of total costs, claim the researchers. Moreover, the extra spending required represents good value for money, as such investment can make significant improvements to the service levels.

In the past when considering the cost of real estate, most research has concentrated on the core costs of moving goods from ports to stores or into the parcel delivery network (when considering e-commerce). Typically, the core supply chain costs are between 5 pct and 10 pct of revenue, with real estate rents representing around 5 pct of these costs (25-50 bps of revenues).

But when considering end-to-end costs, it is worth bearing in mind that there is an implicit cost to consumers who give up their time to shop in real world brick-and-mortar stores, and that stores themselves bear a cost in the retailing of a product. In the past, companies have attempted to minimise overall costs by optimising individual sections of the supply chain and frequently each section would be under the control of a separate manager. According to Prologis Research, “optimising each category does not necessarily optimise the full system.”

Now that supply chains stretch all the way from the factory gates to the end-consumer’s doorstep, it is more appropriate to consider the end-to-end costs. According to a second research paperby Prologis, in collaboration with The Sequoia Partnership, a leading supply chain research group,total costs for e-commerce are 15-20 pct lower for e-commerce in comparison to traditional brick-and-mortar retailing. When looked at in this light the real estate costs are one of the smallest components of total cost. The typical logistics tenant pays USD 10 on transportation and USD 5-7 on labour for every US dollar that it spends on rent. Paying more in order to lease space in an urban logistics centre can significantly raise service standards and thus reduce the implicit costs that are normally borne by the end-consumer. As a result, logistics real estate is set to become more differentiated in the future, with regional space prices based on the cost of development and space closer to the consumer priced on the extra value that it can add to a commodity.

Everything still changing

Splitting orders into individual parcels far from where the end-consumer lives creates additional transportation costs that are an estimated four times greater than the additional inventory costs of a local distribution centre. Additionally, a proliferating number of experimental delivery methods (such as click & collect and product lockers) are increasing the number of channels through which the consumer can be reached and thus increasing retail trade. Such sales methods are proving to be cost competitive with other forms of retail.

To a large extent e-commerce accentuates the trends created by globalisation. To transfer from a chain that supplies bricks and mortar stores to e-commerce requires a 75 pct reallocation of a supply chain’s costs. Such spending has resulted in a 400 pct increase in investment in distribution centres and transportation to consumers. Prologis concludes that for supply chains the only constant is change. The rise of e-commerce is pulling supply chains closer to consumers, driving up demand for costlier, infill logistics space. And it argues these new network strategies are sustainable for two main reasons: e-commerce delivers substantial value to consumers and logistics real estate can create value far beyond its cost. ν