Proposed Third DC: Service-Driven Growth vs. Fixed Cost
A regional distributor serves four markets from two DCs. The West market moves 180,000 units a year at a $6.00 contribution margin per unit. It is currently served from the Central DC on a 5-day standard transit with 91% on-time delivery, the worst in the network. Operations proposes a leased West DC: $1.10M per year in fixed occupancy and labor, inbound freight from the plant rising by $0.18 per unit on West volume, and transit falling to 2 days. Marketing forecasts a 4% volume lift in the West from the service improvement. Total network safety stock would rise from $2.6M to $3.1M because demand pooling is lost. Your carrying cost rate is 20%.
1. Quantify the net annual financial effect of the proposed DC and give a recommendation.
Read the worked answer
Incremental cost
- Fixed: $1,100,000
- Inbound freight: $0.18 x 180,000 = $32,400
- Inventory: 20% x ($3.1M - $2.6M) = $100,000
- Total: $1,232,400/yr
Incremental benefit
- 4% x 180,000 = 7,200 units x $6.00 = $43,200/yr
Net: -$1,189,200/yr. On these numbers the DC is not close to viable - the growth forecast covers about 3.5% of the cost. Recommendation: reject as proposed, but do not close the file. The analysis as given is incomplete: it contains no outbound freight savings, which are usually the largest benefit of a forward DC, and no reduction in expediting or chargebacks. Those must be quantified before a final decision.
2. What volume lift would be required to justify the DC, and what does the answer imply about how to frame the decision?
Read the worked answer
Break-even volume = $1,232,400 / $6.00 = 205,400 units, which is 114% of current West volume - a 114% lift on a market currently growing in the low single digits. That is not a service argument; it is a fantasy.
The implication is that the DC cannot be justified as a revenue play. It can only be justified as a cost play, which means the decision has to be re-framed: build the business case on outbound freight reduction, fewer split shipments, lower expedite spend, and reduced 5-day transit exposure. If those savings plus a realistic lift do not clear the $1,232,400, the answer is no. Ask operations for the outbound freight model by lane before the proposal goes any further.
3. Propose two lower-cost alternatives to the fixed DC and describe how you would test them.
Read the worked answer
1. West pool point with a 3PL. Contract cross-dock space to receive full inbound loads and release daily 2-day ground. Variable cost, no lease, no incremental safety stock at your own book, and reversible in 90 days.
2. Service-tier upgrade on the orders that matter. Buy 2-day transit via premium LTL/parcel for the top slice of West orders by revenue or margin - typically 15-25% of orders carry most of the at-risk revenue. Cost scales with volume and can be dialed back.
Test design: run a 90-day pilot on a defined customer/SKU subset, with pre-agreed success metrics - cost per order, OTIF, order-to-deliver days, and incremental revenue against a matched control group of customers kept on the current service. Cap the exposure at the annual fixed cost you would have committed to the DC, and require a go/no-go decision against the same contribution-margin hurdle used above.