Reducing costs in supply chains may not improve productivity

Roger OakdenLogistics Management, Logistics Planning, Supply Chains & Supply Networks

Trucks at a distribution centre

eCommerce drives storage sector expansion

The drivers of productivity improvement are technological advances in machines, infrastructure development, more efficient organisations and investment in human capital through education and training. But, in developed economies advances in technologies appear to have not transferred to increased productivity over the past 20 years (measured as gross domestic product (GDP) per hours worked).

This has implications in the storage sector, where growth in the number of warehouses, distribution centres and fulfilment centres, is being driven globally by the expansion of eCommerce operations for online order fulfilment. This is occurring because eCommerce fulfilment products are increasingly positioned in more warehouses that are closer to the consume. It is also estimated that eCommerce fulfilment requires about three times the amount of distribution and returns handling space as a retail store fulfilment operation.

A recent report by Interact Analysis estimates that the global number of warehouses reached 150,00 and 11.6b m2 of space at the end of 2020. It also predicts more than 28,000 new warehouses will be required globally by 2025, with more than 50 percent built in China, USA, Japan, India and Germany. Employment in the storage sector is forecast to increase by 50 percent in 2025 to total nearly 13 million workers.

However, 60 percent of all warehouses are in regions where the total cost of labour is less than U$10 per hour, In the US, the average wage at April 2021 for a warehouse worker is U$12.87 per hour, with an additional U$4,687 per year average earnings in overtime payments.

In these circumstances, automation to improve productivity has a low priority, because justification is often based on savings in total labour costs. When total wage costs are low, the incentive is to obtain more low paid workers rather than invest in machines and technologies. For example, the Melbourne Age newspaper recently noted that business investment in Australia for facilities and equipment has averaged 9 percent of GDP for the past 10 years, compared to 12 percent over the previous 30 years. And, prior to the pandemic, overall employment was growing faster than growth in productivity (i.e. a reduction in GDP per hour worked).

Profit is the business objective

The projected increase in the size of the storage sector has implications for a country’s economy, which relies on productivity improvements for increases in living standards of the population. While a business can improve its productivity to increase profits, the objective is to obtain higher profits, not increased productivity. As productivity improvements from better machines and technologies take time and effort to implement, an alternative is to reduce costs, particularly the total cost of labour.

To reduce labour costs, a business can provide ‘individual contracts’ for full and part-time employees. As these contracts are not concluded through bargaining, they usually do not contain provisions for wage increases or improvements in working conditions. Reduced labour costs can also be achieved through eliminating labour on-costs (annual leave, sick leave, injury compensation insurance premiums and superannuation contributions). This is achieved through hiring ‘independent contractors’ (also called ‘gig’ workers) and casual employees or obtaining the required labour force from a labour hire firm – all working on a ‘flexible’ hours basis. These actions can reduce risks in a business:

  • Not being responsible for on-costs means that workers (and the community) must carry the risk and cost of injury, sickness and retirement
  • The risks associated with Interruptions to supply chains are carried by the contractor, casual or labour hire workers, who can be stood down without pay at short notice
  • Reduced spend on training. Workers are expected to gain their own qualification at their expense, even though a high proportion of the benefits are received by the business. When a business is short of a particular skill, foreign workers can be acquired on short term contracts and temporary work visas
  • Rather than risk investment in new equipment and technologies, the incentive is to hire more low paid workers

Making decisions about functions

Making decisions concerning the on-going performance of different functions within a business are governed by two drivers: Strategic Importance of the function to the business and the importance of Operational Performance. When both are high, there is an incentive to retain and improve a function, but when the Strategic Importance of a function is considered to be low, a ‘cost-down’ approach will more likely be considered.

Decisions about functions

An example of making the ‘cost-down’ decision is where consumers do not have a personal connection to the eCommerce fulfilment centre from where they receive their order – price and perfect order and delivery time (Operational Performance) are more important. Therefore, the wages and working conditions of the workers is of little interest, so cost-down and labour work control can be implemented.

However, for organisations so dependent on data and information, the greater cost (actual losses, profits and reputation) is not the workers, but the risk of cyber-attack. which can disable the IT network of a business. It could also be many months before normality is resumed, due to looking for malicious code, that is ‘buried’ in the system and does not ‘awake’ until triggered by an event.

To make the organisation more resilient against an attack, an eCommerce organisation must be pro-active through a combination of technology, processes and people. A cyber-attack is not just an IT problem – it requires knowledgeable and trained people throughout the organisation. But what if your business has a ‘cost-down’ approach to people working in the business – could there be an opportunity to ‘inadvertently’ open a suspicious email or click on an embedded link? The outcome could be expensive.

The approach of chasing short term profits (often driven by an executive bonus scheme) will eventually weaken the business, as it becomes less competitive. If more businesses have a short-term profit strategy, the cumulative loss of competitiveness affects the overall economy of a country. This further opens the door to imports from countries that have a more ‘guided’ approach to their economy, with a recognition of productivity and its effect on an economy.

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About the Author

Roger Oakden

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With my background as a practitioner, consultant and educator, I am uniquely qualified to provide practical learning in supply chains and logistics. I have co-authored a book on these subjects, published by McGraw-Hill. As the program Manager at RMIT University in Melbourne, Australia, I developed and presented the largest supply chain post-graduate program in the Asia Pacific region, with centres in Melbourne, Singapore and Hong Kong. Read More...