Warehouses Aren’t Making Room for the Recovery

By Robert J. Bowman | Supply Chain Brain

You could call inventory and warehouse space the twin evils of the supply chain. Both are big drags on the balance sheet. So it should come as no surprise that the two categories are lagging the recovery – or what’s passing for one.

There’s no question that companies have done a remarkable job of boosting the efficiency of their warehouses and distribution centers. The ratio of real inventory to sales has improved by at least a third over the past 60 years, according to Walt Rakowich, co-chief executive officer of Prologis. Given that he oversees one of the world’s largest owners and developers of industrial real estate, with an emphasis on logistics, he’s in a good position to know.

Rakowich was a speaker at the recent annual convention and expo of the International Warehouse Logistics Association in San Francisco. While the total amount of space continues to rise, he said, it’s not keeping pace with growth in real GDP. The first is expanding at around 1.8 percent a year, the second at around 2.6 percent. And the gap is widening.

Why isn’t supply meeting demand? Industry consolidation is one reason. For another, companies remain extremely gun-shy about committing to new, capital-intensive distribution space. Perhaps they’re still feeling the effects of the just-in-time craze. Spurred in part by the example of the Japanese, who borrowed the JIT concept from the U.S., supply-chain executives have been working for the past 30 years to replace inventory with agility. Practices such as vendor-managed inventory and kanbanmanufacturing have drastically shrunk the amount of raw materials, components and finished goods that need to be kept close at hand. Lower inventories, of course, mean less space needed to store them.

For consumer goods producers with ever-narrowing profit margins – and that’s just about everybody, unless your name is Apple – that’s a wholly positive trend. Until, of course, the real world intrudes. Anearthquake and tsunami, port shutdown or just the everyday challenges that accompany longer supply lines can create the sudden need for buffer stock at the plant or close to end markets. A major manufacturer like Boeing begins to worry whether it can get enough parts from Japanese suppliers to build its much-delayed 787 Dreamliner. At times like that, inventory isn’t so evil after all.

Now throw in a budding economic recovery, and you have a situation where new thinking is required. Rakowich said businesses are indeed moving toward “cautious growth.” Nevertheless, inventory levels are hovering at 4 to 5 percent below where they ought to be. Time to take some of the cash that companies are hoarding, and sink it into new facilities.

Which isn’t to suggest that we need to return to the days of big, labor-intensive warehouses driven by legacy systems. Information technology has taken us too far for that to happen. Warehouse-management software has revolutionized the ways in which facilities utilize their workforces, pick and put away stock, and map the path of goods between the receiving dock and the racks.

Still, distribution operations are going to feel increasing pressure to boost storage space as supply and demand grow further out of balance. “The absorption of warehouse space – actual demand – is beginning to accelerate,” said Rakowich. Average utilization levels have risen from 82.5 percent to 84.5 percent in the past two years. Rakowich believes the trigger point for the acquisition of new space is between 87 percent and 89 percent. Prologis’s own facilities are already running at 92-percent to 93-percent occupied, surpassing 97 percent for operations with more than 250,000 square feet. “All the while, new supply of space is virtually non-existent.”

In fact, the demand for warehouse space never stopped rising during the recession, with the exception of 2009. For this year, Rakowich projects a need for between 175 million and 200 million square feet in the U.S. And that doesn’t even account for the loss of space due to obsolescence, which takes between 50 million and 75 million square feet off the market annually. In other words, developers must add that much just to stay constant – yet the last three years have barely hit the 50 million square-foot level. Compare that with 1993, the low point of the decade in terms of new space, when 75 million square feet was added.

Let’s be clear: businesses aren’t dawdling out of a sense of pessimism. On the contrary, said Rakowich, they are increasingly bullish about the economy, with investors continuing to drive up values and rents poised to grow as a result. Prologis’s Industrial Business Indicator index, based on regular customer surveys, has shown consistently positive sentiment since late 2009.

On the downside, there’s one abiding legacy of the Great Recession: the refusal of banks to lend money in meaningful amounts. Rakowich said that’s less of a problem today for big, well-capitalized businesses like Prologis. And we have seen some movement in the commercial lending sector over the past year or so. But smaller businesses, trying to finance speculative buildings even in a decent market, would have to put up equity of between 30 and 50 percent. Unfortunately, they’re not the ones with the huge cash reserves. “It’s very difficult for the moms and pops in business to get financing,” said Rakowich.

So the economic picture is brightening. Market occupancies are approaching 90 percent for the first time in five years. Conditions are clearly improving, and the fundamentals look good. But the warehouse market has yet to respond. As the saying goes, something’s gotta give.