Expert Column Recent Expansion Status and Location Requirements of Fulfillment Center

Accelerating Change into Fulfillment Center With the changing trend of distribution network evolving into omni-channel or multi- channel network, distribution centers are transforming into fulfillment centers. Previously, distribution centers revolved around B2B transactions and were aimed at achieving efficiency through operation based on stabilized demand. However, as traditional distribution companies based on brick-and-mortar stores are aiming to introduce Online-to-Offline (O2O) sales network, fulfillment centers aiming to secure high level of serviceability in order to deal with transactions having high uncertainty are being integrated in the logistics networks.

Nonetheless, such recent trend should be distinguished from the distribution network strategy of pure players who have established fulfillment centers solely for the purpose of online sales from the beginning. Even though everything is being sold online nowadays, 80% of the distribution market still relies on the traditional distribution network, which signifies high urgency and impact of omni-channel fulfillment center. Due to the spread of COVID-19 pandemic, the pre-established offline stores of the distribution companies have become weakness, generating inefficiency such as high rent and labor costs. However, those distribution companies will be able to secure higher competitiveness than professional online distribution companies by leveraging customer proximity, which is one of the biggest strengths of offline stores.

Generally, it is difficult to design warehouses to increase storage efficiency per unit area because “small shipment of various items” is the core of efficiency for online orders targeting consumers. Since fulfillment centers are designed to speed up the shipment process, it is reported that the required area to store the same amount of cycle stock is about three times larger than that of traditional warehouses. Unlike large distribution centers of online distribution companies, fulfillment centers are not highly automated because they rely on pickers with more emphasis on time flexibility and operate on small scale. In terms of location, unlike existing distribution centers aimed at economies of scale based on integration and enlargement, fulfillment centers are expanding into micro-fulfillment centers (MFCs) since they focus more on the proximity to consumers despite expensive rents. In addition, mobile technology such as crowd shipping has been applied to drastically reduce the unit costs of transportation and enable quick commerce within few hours. Fulfillment center has now become a key facility and a source of competitiveness for companies to drive innovation in the distribution industry.

Traditional distribution companies have various advantages over online distribution companies based on accumulated experience and know-how of having operated offline stores for decades in areas with a large transient population. In addition, it is desirable to establish strategies to reduce overlapping investments in O2O sales and minimize the increasing investment in the fulfillment centers by utilizing idle areas of existing offline stores.

One notable example is Olive Young, which is one of the most popular drug store brands in South Korea. Prior to the pandemic, Olive Young was an offline-based distribution company where consumer experience mostly centered around the sale of over-the-counter medicine and cosmetics products. With the surge of online purchases since the pandemic, however, the company has taken a strategy to expand sales by connecting online and offline (O2O) services and announced plans to establish six more branches in Mapo-gu, Guro-gu, Gwanak-gu, Gwangjin-gu, Nowon-gu and Seongnam-si, starting with two MFCs in Gangnam-gu and Seongnam-si in 2021. Apart from this, the company is performing renewal of fulfillment function in 1,272 offline stores (as of 2022 1Q) in order to create synergy in connecting organically with MFC. In addition, Olive Young is working with delivery service agency Vroong to establish an urban transportation network to enable quick commerce (service name: Oneul Dream) which guarantees delivery within three hours. As a similar O2O collaboration case found in overseas, Instacart has modularized fulfillment function in partnership with offline-based local grocery stores and dispatched pickers (shoppers) regularly, successfully creating a win-win business model that leverages grocery stores as the company’s fulfillment center without making additional investment in offline stores. Customers will be able to enjoy fast delivery services by delivering orders via mobile application that leverages customer proximity of existing stores. Based on such quick delivery services, Instacart was able to surpass Amazon Fresh – an online distribution ‘dinosaur’ – in the North American online grocery market.

Flow of Expansion 2 (Collaboration Strategy with Existing Distribution Centers) Meanwhile, there are movements to further integrate these fulfillment center functions into traditional distribution centers. Since only the consumption pattern of customers change from offline to online without much change in total demand, idle space is inevitably created within the distribution centers. Therefore, there is a new trend of creating automated online fulfillment centers by utilizing this idle space. Although these centers are far from customers compared to micro-fulfillment centers in terms of distance, both offline and online transactions are processed together under one roof, which will create pooling effect in terms of utilizing human and material resources.

In fact, this strategy has a cost advantage compared to micro-fulfillment centers in that the infrastructure of existing distribution centers can be shared in the areas of manpower supply or utilization of equipment. It also has the advantage of minimizing the inefficiency of inventory movement (e.g., the inefficiency risk of reverse logistics between local distribution centers and MFCs) created by the volatility of consumer demand. However, since the proximity to consumers is lower than that of MFC, last-mile operation incurring extremely high cost is an unavoidable problem in implementing quick commerce. To address this problem, it is necessary to consider ways to secure urban distribution function (swiftness, flexibility, and conciseness) by using existing express delivery companies that are in charge of last-mile delivery service.

Location Requirement by Case Basically, the location requirements of traditional distribution centers that serve as the backbone of the supply chain are similar to those of traditional companies. However, the importance of each requirement has changed dynamically along with the changes in the role and operation method of distribution center in the supply chain. In fact, according to an empirical study on changes of pattern of location selection requirements by period (1951-2016) of 5,364 distribution centers in California, U.S.A. (Kang, 2020), small distribution centers of 100 k SQF or less were established in the commercial area of old cities during the construction phase of distribution infrastructure that lasted until the 1980s, as shown in the figure below. Since then, as the industrial road infrastructure develops and the load efficiency of transportation increases, the proportion of transportation cost decreased from supply chain costs, leading to enlargement of the distribution centers that moved away to the outskirts of the cities. Looking at the patterns since the 2000s (i.e., when the dot-com boom has begun in earnest), however, it should be noted that the patterns of distance and size are not just peak curves but rather have hump-shaped double peak structure. This can be interpreted that the location selection criteria of distribution centers are being polarized with online distribution placing more importance on distance from customer for fulfillment and offline distribution emphasizing storage efficiency achieved through low land prices, respectively.

Based on this trend, the criteria for selecting location requirements for large-scale corporate distribution centers (DC), online fulfillment centers (OFC), and urban micro-fulfillment centers (MFC) are summarized as follows.

First of all, currently large-scale corporate distribution centers focusing on economies of scale and availability of inventory, land prices are very important. In addition, accessibility to transportation infrastructure is important because the proximity to consumers is lower in inexpensive areas. Although human workforce has been largely automated in recent years, accessibility to the labor market is yet another important factor since reliance on human labor is still high. Since distribution centers are largely restricted for being unpleasant facility (possibility of traffic accidents of large trucks, inflow of low-wage workers, etc.), they were often located within the cluster complexes established by the government.

In contrast, OFCs have greater access to the consumer market as more emphasis is put on timeliness, and they are less dependent on the labor market as more automation is carried out internally to handle small cargo. Therefore, OFCs were less restricted in terms of location as the need for middle-class management manpower increased compared to manual workers. However, since enlargement of fulfillment centers is still pursued in order to achieve economies of scale, reliance on land prices as well as transportation infrastructure is still significant.

Lastly, the location requirements of MFC for omni-channel distribution are different from the previous two cases. First of all, high accessibility to the consumer market is crucial in order to achieve quick commerce, and reliance on existing road infrastructure is low because it takes transportation methods (subway, bicycles, scooters, vans, etc.) befitting urban road traffic conditions rather than using roads or airports in the urban area. In terms of operation, since MFCs are operated on a small scale and are not automated, they often utilize offline stores and offices as the one in the photo below (Amazon’s MFC located in Manhattan). MFCs also have excellent scalability and can easily secure manpower thanks to large supply of idle manpower coming from the urban area. However, Amazon – one of the most notable pure player in the market – has been changing its strategy in recent years to focus more on the online grocery market rather than operating MFCs for all of its products since the end of 2021. This movement shows Amazon’s commitment to build a large-scale OFC focusing on its unique strength, instead of building an MFC with low entry barrier for latecomers such as existing distribution companies.

# References Kang, S. (2020). Warehouse location choice: A case study in Los Angeles, CA. Journal of Transport Geography, 88, 102297.

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