Strategically Speaking: 12 Costs to Consider in Outsourcing Distribution
In previous columns, I've explored the strategic reasons to consider outsourcing distribution operations and the request for proposal (RFP) process for outsourced distribution partners. Now, let's assume that you have evaluated all the third-party proposals and selected the finalist among the various bids.
With the exception of implementation, evaluating the costs of in-sourced versus third-party distribution is the most complex step in the process of determining whether outsourcing is, in fact, in your company's best interest. The outcome of the evaluation process may well be the shutdown of your company's captive distribution operations, so a carefully constructed analysis is mandatory.
The evaluation should consider quantitative and qualitative factors of both the in-house and outsourced options, including the one-time transition costs that are associated with moving distribution operations to a third-party provider, and a forthright assessment of the on-going capital and operating costs of maintaining a captive operation.
It goes without saying that the evaluation should have a multi-year view and should consider "environmental factors"—i.e., how the business might change in the years ahead.
There is little doubt that print-on-demand and short-run digital printing are here to stay, and the recent iPad announcement augers well for the e-book. Both developments suggest that the need for fixed warehouse space is likely to decline in the years ahead,. Unless your organization has plans for a significant expansion in the publishing program or acquiring another company, you may find yourself with more space than you need or can afford. Looking carefully at the long-term is essential.
Evaluating Status Quo
Evaluating the status quo refers to projecting the baseline costs for the current in-house distribution operations, including anticipated changes in costs because of an expiring warehouse lease, ongoing maintenance and leasehold improvements—will the warehouse need a new roof next year?—and any planned productivity improvement initiatives.
Moving warehouse operations is a complex undertaking under the best of circumstances, and prudence dictates that your analysis consider all the pluses and minuses of maintaining the status quo. The figures developed in this phase of the analysis should cover a multiyear horizon (5 years minimum) and should be realistic—this is not the time to put on your rose-colored glasses in an effort to maintain the status quo.
One-Time Costs of Outsourcing
The first step in the analysis is to consider the one-time costs that would be associated with outsourcing your captive distribution operation. Many of these costs can be developed while you are waiting for the vendor proposals to be submitted. At minimum, the one-time costs should take into account:
1. Moving Costs: The cost of transporting the inventory from the publisher's warehouse to the third-party distributor is likely to be significant. In addition to the out-of-pocket freight costs, the transition schedule has to be set to minimize the risk to the business and ensure the new arrangements will be in place before the start of the publisher's busy season. This almost certainly will require overtime from the publisher's warehouse staff, another cost that should be considered.
2. Inventory Write-Offs: Moving to a third-party distributor is the perfect time to dispose of the organization's slow-moving inventory and finally make that move to print-on-demand. Only move the inventory you believe you can sell—the rest should be destroyed or remaindered, and the expected cost recognized in the evaluation.
3. Human Resource Costs: This is undoubtedly the most difficult element in the evaluation, but essential to understanding the full picture. This component should consider the cost of severance, vacation payouts, benefit continuation, stay bonuses and out placement.
4. Fixed Asset Write-Offs: The decision to shut your warehouse may necessitate writing off the unamortized portion of infrastructure investments including racking, material handling equipment, computer systems and lease-hold improvements.
5. Interface Costs: Business systems do not connect automatically, and there will inevitably be resources required to link the publisher's ERP system with the third-party distributor. Beyond estab- lishing the initial connection, ongoing reporting requirements may require specialized technology resources be temporarily brought on board to build the interfaces needed for ongoing business management.
6. Transition Team Expenses: Outsourcing distribution operations is one of the most significant business decisions a publisher can make. Flawless execution is essential. The publisher should create a dedicated team to plan and manage the transition. The team should have representatives from all appropriate functional areas including HR, legal, finance and operations, and be staffed by the organization's best people. The transition team is not a place to stash the organization's personnel problems—the stakes are simply too high.
Temporary resources may be needed to backfill for the employees assigned to the transition team. In addition, the transition team will need adequate—and no doubt incremental—funds for travel, lodging and meals. It needs to establish a presence at the third-party provider—publisher visibility during the transition is essential to success.
7. Contingency Provision: No matter how careful the plan, some project expenses will almost certainly be higher than budgeted, or unanticipated costs will surface. The calculation of one-time costs should include a contingency provision of 10 percent of the total one-time costs identified above. The contingency provision is not a license to allow the identified one-time costs to go unmanaged, but recognition of the fact that this is a complex undertaking and the unexpected is to be expected.
As in any well-run project, measurement of actual transition costs versus the project budget should be ongoing, and the total transition cost reforecast biweekly—at minimum—or more frequently should special circumstances arise. These steps will ensure potential problems are identified and increase the chances that problems can be corrected to bring the project back on schedule and budget.
Most third-party distribution agreements are structured on a percentage-of-sales basis, with the distributor receiving a share of the publisher's net sales (gross sales minus returns). Some would suggest that a laundry list of a la carte services is a better way to conduct the analysis, but in my experience, this approach introduces complexity that is difficult, if not impossible, to manage and an uncomfortable degree of subjectivity.
Assuming that the agreement is based on percentage of net sales, your business will undoubtedly require special services, such as applying price stickers, re-jacketing, etc. Your job is to confirm that all the required processes have been considered and priced out by the bidders on the same set of assumptions, and all the potential "extras"—e.g., returns above a certain percentage of gross sales will incur incremental charges; the contract will allow you to store a specified number of units per month, and excess units will incur an additional cost.
As previously mentioned, a multi-year view of your business is needed. The evaluations of both the status quo and outsourcing options should incorporate the same growth and operating assumptions in your organization's strategic plan to ensure that the supporting distribution infrastructure is consistent with the anticipated needs.
Here is a check list of the hard costs (those that impact your monthly financial statement) your analysis should consider in evaluating the outsourcing option:
1. Distribution Costs: Assuming the percentage of sales method, what will your annual distribution costs be?
2. Returns Penalty: Do you expect your returns to exceed the contact threshold and incur penalty fees?
3. Storage Costs: Do you expect your publishing program to significantly increase the amount of space you will occupy? Do you have a comprehensive plan to move aggressively to POD to reduce your space requirements and strengthen working capital management?
4. Special Services: What are the estimated annual costs for services such as re-jacketing, errata sheets, applying price stickers, etc.?
5. Incremental Freight Costs: Will third-party provider's location increase or decrease the cost to move books from your printer to the distribution center? Does the provider offer in-house POD that reduces your annual freight bill?
This list is by no means exhaustive; the objective is to be sure your analysis considers all significant on-going and one-time costs of the status quo and outsourcing, as well as the working capital implications. Outsourcing to a third-party can offer significant improvements to your cash flow (albeit at a price) that should be carefully considered.
Book publishing is not a cash-rich business, and maintaining a captive distribution operation can place significant demands on limited financial resources. Outsourcing to a third-party provider offers the opportunity to redeploy capital into product development that might otherwise be required to maintain infrastructure that is becoming increasingly archaic as the e-book and print-on- demand become institutionalized.
David Hetherington is director of major account sales for Baker & Taylor's Digital Service Group and an adjunct professor at the Pace University Graduate School of Book and Magazine Publishing. He was previously managing director for strategic business development for Integrated Book Technology, and has held senior positions in finance, operations and manufacturing with some of the industry's largest firms, including Simon & Schuster, Reader's Digest Association, BearingPoint Consulting, Wolters Kluwer Health and Columbia University Press.