Let's Automate
The CEO of a large retail warehouse is considering investing in a new software solution to optimize operations. The main problem is determining if this investment is a wise decision for the business.
Identify the Problem
The candidate should ask questions about geography, business model and company objectives
Some questions that can be asked are
Geography
Warehouse Location and Operations:
- Where is the main warehouse located?
- Does the warehouse serve multiple locations? If so, where are they?
- Are there any geographical constraints or advantages that impact your warehouse operations?
Range of Action:
- Does your warehouse ship products nationally, internationally, or both?
- What percentage of your shipments are domestic versus international?
- Are there specific regions or countries that are key markets for your business?
Business Model
Operational Processes:
- Can you describe the current operational processes in your warehouse?
- What are the key functions or tasks performed within the warehouse?
- How are inventory management and order fulfillment currently handled?
Revenue Streams:
- How does the warehouse generate revenue? Is it through storage fees, handling fees, or other services?
- Are there any additional services provided by the warehouse that contribute to revenue (e.g., packaging, shipping, value-added services)?
Efficiency and Productivity:
- What are the main challenges or bottlenecks in your current operations?
- How is productivity measured and tracked in the warehouse?
- Are there specific areas where you believe the new software could significantly improve efficiency?
Cost Structure:
- What are the primary costs associated with your warehouse operations (e.g., labor, equipment, maintenance)?
- How does the current cost structure impact your overall profitability?
- Are there any recent changes in your cost structure that you are trying to address?
Company Objectives and Current Situation
Company Objectives:
- What are the primary objectives you hope to achieve with this new software solution?
- Are there specific KPIs or metrics you aim to improve through this investment?
- How does this software investment align with your overall business strategy and long-term goals?
Technology and Innovation:
- What existing technologies are currently in use in the warehouse?
- How have previous technology investments impacted your operations?
- Are there any integration concerns with your current systems if the new software is implemented?
Stakeholder Involvement:
- Who are the key stakeholders involved in this decision-making process?
- How will the implementation of this software impact various teams within the warehouse?
- Are there any concerns or feedback from the staff regarding the adoption of new technology?
While all of the above are valid questions, the candidate should bucket them and show a clear path to getting the information they need. The key pieces of information they should understand is the business model of the warehouse and the KPIs used to measure success
Frame the solution
The structure of the candidate will depend on how they handle the formulate the problem statement but you should guide them towards focussing on the costs. It would be acceptable for the candidate to start from the revenue side and work down towards cost. A proposed structure follows. Note that the candidate is not expected to build it on their own but they should start from the first level and slowly moving towards more granularity. Note that it is of for the candidate to include the initial investment in the structure itself. We are not doing it here but the candidate can do it if they wish to do so.
They should be able to list labour, equipment, insurance and storage space as the key drivers of costs. You should then guide the candidate to elaborate on labour and equipment. They should be able to segment labour across direct, and indirect workers and overheads. This segmentation is not strictly necessary but they should be able to identify low-skilled and high-skilled labour as two separate segments of the workforce.
In terms of equipment, they should be able to relate the equipment needed with the business model, breaking it down into lifting and handling, storage and packaging and shipping.
They should mention other items, such as insurance and storage space, to show they have a good understanding of the overall cost drivers.
Finally, they should include the cost of automation in the cost structure as they should recognise that automating will have a recurring cost that needs to be factored in the new setup. If they do not do it, they should mention it later in the analysis.
At this point the candidate should mention that the equation they are trying to solve is investment/(yearly cost savings)<2.
Lead the analysis
The candidate at this point would enquire about the cost of the investment.
| Annual Maintenance and Support Costs | 30,000/year |
Assumptions and Data Collection
Current Costs:
- Gather current labor costs, including wages, benefits, and any other associated costs for both high-skilled and low-skilled workers.
- Collect current costs of equipment, maintenance, and operation.
- Include depreciation of existing equipment.
- Include current insurance premiums.
Expected Savings:
- Estimate the percentage reduction in labor costs due to automation and efficiency improvements.
- Estimate the percentage reduction in equipment costs due to better utilization and maintenance.
- Estimate the reduction in overhead costs due to streamlined operations.
- Include savings from reduced insurance premiums.
- Factor in ongoing maintenance and support costs for the new software.
Example Calculations
1. Labor Costs
Current Labor Costs:
High Skilled Direct Labor: $500,000/year
Low Skilled Direct Labor: $300,000/year
High Skilled Indirect Labor: $200,000/year
Low Skilled Indirect Labor: $100,000/year
Overheads (administrative, management): $150,000/year
Total Current Labor Costs: $1,250,000/year
Expected Savings:
High Skilled Direct Labor: 10% reduction
Low Skilled Direct Labor: 20% reduction
High Skilled Indirect Labor: 15% reduction
Low Skilled Indirect Labor: 25% reduction
Overheads: 10% reduction
Savings Calculation:
High Skilled Direct Labor Savings: $500,000 * 0.10 = $50,000/year
Low Skilled Direct Labor Savings: $300,000 * 0.20 = $60,000/year
High Skilled Indirect Labor Savings: $200,000 * 0.15 = $30,000/year
Low Skilled Indirect Labor Savings: $100,000 * 0.25 = $25,000/year
Overheads Savings: $150,000 * 0.10 = $15,000/year
Total Labor Savings: $50,000 + $60,000 + $30,000 + $25,000 + $15,000 = $180,000/year
2. Equipment Costs
Current Equipment Costs:
Lifting and Handling Equipment: $200,000/year
Storage Equipment: $150,000/year
Packaging and Shipping Equipment: $100,000/year
Total Current Equipment Costs: $450,000/year
Expected Savings:
Lifting and Handling Equipment: 10% reduction
Storage Equipment: 15% reduction
Packaging and Shipping Equipment: 20% reduction
Savings Calculation:
Lifting and Handling Equipment Savings: $200,000 * 0.10 = $20,000/year
Storage Equipment Savings: $150,000 * 0.15 = $22,500/year
Packaging and Shipping Equipment Savings: $100,000 * 0.20 = $20,000/year
Total Equipment Savings: $20,000 + $22,500 + $20,000 = $62,500/year
3. Depreciation of Equipment
Current Depreciation:
Annual depreciation of existing equipment: $50,000/year
Reduction in Depreciation:
Reduction percentage: 15% (same as reduction in equipment costs)
Depreciation Savings: $50,000 * 0.15 = $7,500/year
4. Insurance Premium Reduction
Current Insurance Premium:
Annual insurance premium: $80,000/year
Expected Reduction in Insurance Premium:
Reduction percentage: 10%
Savings Calculation:
Insurance Premium Savings: $80,000 * 0.10 = $8,000/year
5. Ongoing Maintenance and Support Costs
Ongoing Maintenance Costs:
Annual maintenance and support costs for the software: $30,000/year
Total Cost Savings
Total Annual Savings:
Labor Savings: $180,000/year
Equipment Savings: $62,500/year
Depreciation Savings: $7,500/year
Insurance Premium Savings: $8,000/year
Total Annual Savings: $180,000 + $62,500 + $7,500 + $8,000 = $258,000/year
Payback Period
Initial Costs:
Software Purchase: $150,000
Installation and Integration: $50,000
Training: $20,000
Total Initial Costs: $150,000 + $50,000 + $20,000 = $220,000
Total Annual Financial Impact:
Total Savings: $258,000/year
Less Ongoing Maintenance: $30,000/year
Net Annual Savings: $258,000 - $30,000 = $228,000/year
Payback Period Calculation:
Payback Period = Total Initial Costs / Net Annual Savings
Payback Period = $220,000 / $228,000 ≈ 0.96 years
This means that the investment in the new software solution will pay for itself in approximately 0.96 years (about 11.5 months), providing significant savings and reduced operational costs.
Provide Recommendations
The analysis indicates significant cost savings and operational efficiencies, with a payback period well within the target of 2 years.
Key Savings Areas:
Payback Period: 0.96 years (approximately 11.5 months).
Labor Costs: Annual savings of $180,000.
Equipment Costs: Annual savings of $62,500
The investment in the new software solution is a financially sound decision that will enhance operational efficiency and reduce costs effectively.
