LOGISTICS AND E-COMMERCE. The impact of E-commerce on logistics real estate

LOGISTICS AND E-COMMERCE The impact of E-commerce on logistics real estate May 2013

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Introduction The stormy growth of online retail sales has received ample attention, but its impact on the logistics behind it is to a large extent still unclear. Although e-commerce is recognised as a driver of demand for distribution space, it cannot be matched with the fact that retail sales volumes are not growing. This implies that the functioning of the logistics property market is not well understood. Reason for CBRE s Dutch Industrial & Logistics team to conduct in-depth research into the topic of e-commerce logistics. This report provides an overview of the research and its conclusions, explaining the way logistics property functions and how e-commerce is changing the requirements for warehousing. The results provide essential information for all parties involved in logistics warehousing, with a focus on investors and developers. Why logistics property? To be able to explain the impact of e-commerce, the nature and purpose of logistics property need to be understood first. In contrast to general belief, logistics property is not a clearly marked category that ticks boxes in terms of building specifications, such as loading docks, free height and floor load capacity. Logistics property, in fact, is the physical result of the functioning of supply chains. More specifically: imperfections in supply chains lead to the creation of logistics property. The demand and supply of goods need to be coordinated and geared towards each other in terms of location, time, and quantity. Imperfections in these factors result in the need for storage and distribution processes. Storage and distribution are the two basic functions of logistics property and to accommodate these processes, logistics property is developed and used. In a traditional supply chain, the physical and commercial channels are equal. The end of the chain is formed by the retail store, where consumers can make their choice out of the available products. Consumer behaviour is, therefore, partly determined by the available product range. These traditional supply chains have a hierarchical structure in which one or more central distribution centres supply the stores with products. These distribution centres, in turn, receive the products from wholesalers, who also have their own distribution centres. A final step back in the chain is the distribution centre of the producer. Following the chain downstream both stock size and shipment size are reduced. YES Basic function Distribution NO Classification logistics real estate PARCEL HUB X-DOCK 1ST LINE BUILDING PRODUCTION DATA CENTRES NO Basic function Storage DISTRIBUTION CENTRE COMMIDITY STOCK YES The interaction of the two basic functions of storage and distribution determine the role of the logistics property that results from it. If we display the two basic functions on an X and Y axis, we get a simplified matrix that allows us to determine basic types of logistics property. The different combinations of distribution and storage provide us with different types of property. Cross docks or cargo terminals are, for example, sites where no storage takes place. Goods enter the site, are rearranged and repacked in different shipments, and leave again, often in a short period of time. The other side of the spectrum offers facilities which are only meant for storage. Goods only occasionally enter or leave these sites, and little staff is needed. In a distribution centre, both the storage and distribution function are combined on a highgrade level. This requires a high degree of organisation and an efficient building lay-out. 4 Logistics and E-commerce

E-commerce logistics The growth of e-commerce has a profound impact on traditional supply chains, where the commercial and physical channels are combined in the retail stores. In the case of e-commerce operations, the commercial and physical channels are split and operate independently. An important consequence is that consumer behaviour is not restricted by the physically available range of goods anymore. Consumers can order virtually any product they require, in every quantity and at any time. This changes the supply chain from a push (to the store) to a pull process (by the final consumer). The physical spot where this change is implemented is the distribution centre. Previously structured to arrange large shipments (fully loaded trucks) at fixed times to fixed delivery addresses, the key factor now becomes the direct delivery to consumers (B2C) and, as such, the fulfilment of consumer requirements. Consumers, who before convened in a store to make their purchase, are now separately placing their orders which have to be processed directly by the distribution centre. Due to this change, the number of orders in the distribution centre increases substantially. Moreover, each order only has a few products (order lines) - usually between one and five, and the number of units per order line is limited to one or two pieces. This process change is the driver of new demand for logistics space. In an e-commerce operation, we will find a large range of products and low stock levels per product. The products can no longer be stored on pallets, but are mostly kept in crates or boxes, or on shelves. The products must be readily accessible for order picking, so a floor location is preferred above storage in racks. The result is a strong reduction in the stock density (the amount of products per square metre), compared to traditional storage solutions. E-fulfilment It may be argued that the handling of e-commerce orders is not only about logistics, but also about marketing. In e-commerce, the distribution process is no longer just an efficient logistics operation, but also, and perhaps especially, a means to live up to the expectations of the customer. If the service of a web shop is not reliable, consumers can switch to the competition by just one click. E-commerce, therefore, is moving the commercial channel into the distribution centre. This is why reliable logistics services are more important than ever. Errors in the logistics process will have a direct impact on the consumer and hence on any (follow-up) purchase. In order to meet consumer expectations, many supporting activities have to be implemented. These include services that add value to the products, control shipments or fulfil administrative duties. These services, generally referred to as Value Added Logistics (VAL) and Value Added Services (VAS) have already increasingly been implemented in traditional distribution centres, E-fulfilment Consumer 6 Logistics and E-commerce

particularly when it concerns international operations. Such a distribution centre with a high level of VAL/VAS activities has been coined a Logistics Service Centre. In e-commerce, however, the scope and intensity with which VAL and VAS are needed are of a different magnitude. The direct impact on customer satisfaction and sales performance is the main reason. The result is the emergence of an enhanced type of logistics service operation, called e-fulfilment. Below figure shows to what extent the e-fulfilment center distinguishes such additional processes in comparison to a basic distribution centre and the traditional logistics service centre, where VAL and VAS have already been implemented. The table shows that the e-fulfilment centre in fact hardly distinguishes any new activities compared to traditional solutions. The intensity with which the processes occur, however, makes it necessary to structure the operation differently and, therefore, adjust the lay-out of the warehouse. Most importantly, the handling of returns can be appointed as a new, e-commerce specific activity, due to the nature and size of this process in an e-fulfilment center. The taking of product photos, in order to be able to market them on the website within the shortest possible time, can also be seen as a new activity. Basic distribution Traditional distribution center E-fulfilment Core activities: Storage Distribution Core activities: Storage Distribution + VAL-activities: packing & `labelling customising assembly quality control + VAS-activities: order management inventory management customer service financial services Core activities: Storage Distribution + VAL-activities: packing & `labelling customising assembly quality control + VAS-activities: order management inventory management customer service financial services + e-commerce activities return handling photography Logistics and E-commerce 7

Returns Returns of purchased products are often mentioned as one of the key processes of an e-commerce operation, and rightfully so. The scope of returns in an e-fulfilment center is such that it can be considered a new, e-commerce-specific activity. A wide array of return types can be distinguished in e-commerce: items that could not be delivered, defective or damaged products, incorrectly delivered products, products that do not fit the purchaser s requirements and products that were deliberately ordered in excess to allow a product comparison at home. The purchasing behaviour of consumers and the service of web shops, therefore, cause substantial additional return flows. As explained, the consumer s choice is traditionally limited to the stock in the physical store and the amount of items that can, or may, be carried into the fitting room. Nowadays, customers of mail order companies or web stores can order much more items than they need, to try them extensively at home and to subsequently send the products back that they do not require. Research has shown that the percentage of products that is returned differs by product type and web store. A percentage between 10% and 20%, however, can be considered standard. As studies show, rates of even 40% to 50% can be seen for women s fashion. The pan-european retailer Zalando, for example, has reported comparable figures. Returns are therefore an extensive and costly process. Besides double transport costs, most companies have to set up a separate process for the return flows. Peak traffic E-commerce operations experience strong fluctuations in the amount of orders that consumers place. There are seasonal effects and differences within a day. In general, the seasonal effects are similar to what is common in the traditional retail market. The daily pattern shows low volumes in the morning and a sharp increase in the afternoon and evening, when consumers return from work or school. Both effects have a different pattern frequency and different peaks and troughs in volume. The general trend is a deviation of -50% to +100% compared to the average order volumes. Both effects can strengthen each other, for example in the month of December, leading to even greater peak traffic. E-fulfilment requirements It is now clear that the roles of the two basic functions of logistics proper ty (storage and distribution) are changing profoundly by e-commerce handling. This requires a different physical solution and, therefore, different requirements to the lay-out of the warehouse. The impact is visualised in the following table. The changing nature of the storage and distribution functions are drivers of the specific requirements regarding location and building specifications. These requirements can be captured under Location, Quantity of space and Quality of space. The effects, and their comparison to traditional distribution, are displayed in the following table. Photography Making pictures of the products immediately after arrival in the e-fulfilment center is essential for marketing. In-house photography has a positive effect on the time-to-market: this way new products received by the e-fulfilment center can be made available for online purchase within 48 hours. A second important aspect is the accurate visualisation of the products. This is decisive for site visits and successful sales. In this way e-fulfillment and marketing have close links with each other, whereas the amount of space required for separate photo studios in the e-fulfilment center is limited. 8 Logistics and E-commerce

What does this mean for the real estate market? The most important aspect for the real estate markets is the extra demand for space. In order to facilitate the wide product range and the large flow of returns, significantly more space is needed than in a traditional operation with a comparable volume of goods. Mezzanine floors are very well equipped to satisfy this extra need for space, as the requirements in terms of free height and floor load capacity are much lower than in case for traditional distribution. Immediate access to a sufficiently large pool of labour is also essential, as are the facilities required to provide efficient and comfortable working conditions for the warehouse staff. As can be seen from the table, the requirements for an e-fulfilment (Multichannel/ Single channel) centre are more complex than for a traditional solution. In order to place the e-fulfilment centre in a similar scheme as our basic storage/ distribution matrix, a different and more elaborate definition of the axes is necessary. This can be seen in below figure where the classification of logistics property is based on the complexity of the processes and the stocking functions, rather than on a binary yes/no division. Pick-up points Pick-up points are not a new phenomenon as such, but the business-to-consumer character of e-commerce is changing their nature. Initially, existing industrial property will be used to establish Pick-up Points (PUP) or Pick-Up Drop-Off (PUDO) sites. Consumers can collect their products here, and in order to cater for them, the property needs to have retail-like features. Above all, the strength of the location is determined by the number of operators using the PUP or PUDO, as this determines the amount of customers. Mechanisation Another difference with traditional distribution is the extent to which e-fulfilment processes are, or can be, mechanised. Virtually no e-fulfilment process can operate efficiently without a degree of mechanisation. For combining orders and packaging shipments, conveyors and sorting systems are frequently used installations. This requires changes to the accommodation in terms of fire safety and climate control. This means that for e-fulfillment solutions a high level of investment is necessary. It is relevant to note that investments have to be recovered through high volumes (many orders) and a long-term use. Complexity of the processes High 1ST LINE BUILDING PARCEL HUB PARCEL HUB X-DOCK DISTRIBUTION X-DOCK CENTER 1ST LINE BUILDING PRODUCTION 1ST LINE DATA BUILDING CENTRES PRODUCTION DATA CENTRES Low PARCEL HUB X-DOCK COMMIDITY STOCK PRODUCTION DATA CENTRES DISTRIBUTION CENTER COMMIDITY STOCK DISTRIBUTION CENTER COMMIDITY STOCK E-fulfilment center Multichannel E-fulfilment center Single channel E-fulfilment center Multichannel E-fulfilment center Single channel E-fulfilment center Multichannel E-fulfilment center Single channel New Classification logistics real estate Essentially, a multichannel e-fulfilment centre is the most complex form of the storage/distribution matrix. No Stock keeping Distribution center Distribution center Bulk stock Pick-stock Virtual/ return Storage Distribution center 10 Logistics and E-commerce

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New development The requirements of e-fulfilment are creating a challenge for the property market. On the one hand, end users desire modern, high-grade facilities that are customised to their own specific e-commerce processes. On the other hand, they are very sensitive for occupation costs and are generally only willing to commit to short-term lease contracts. Most existing properties are not able to bridge this gap, leading to opportunities for developers. The limited availability of finance, however, poses a severe threat. Conceptual development might prove to be a solution. Conceptual development involves the creation of a concept, or a vision on future market developments. Conceptual development means the realisation of this vision in a spatial context. The developer will have to take the initiative to work out the e-fulfilment concept in close cooperation with his partners, the end user and the investor. They will have to be involved in the early stages of the development process. Investment opportunity Although there is no one size fits all when it comes to the real estate solution for e-commerce, e-fulfilment is a property segment that in terms of location, quantity and quality has to meet a number of basic requirements. This has implications for the marketability of the object. Property that was previously regarded as obsolete, for example because the free height was too low or the mezzanine floors were too large, might again come into favour because of its location. On the other hand, built-to-suit e-commerce warehouses might prove to be only workable for one specific user and can become obsolete very rapidly. One should bear in mind that e-fulfilment centers are not user-specific, but use-specific. Investors should understand that a new standard for logistics property is created. E-commerce is a separate process, with a growing need for space in the middle and long term. There is also a strong need for higher property quality, which requires a higher investment, but also provides the opportunity to engage into long-term lease contracts with the end user. The risks are limited as the fundamental change in consumer behaviour means that demand for this type of space will remain. This provides the opportunity to create a long-term investment product with a committed end user and an attractive direct return. Other real estate effects Besides the emergence of e-fulfilment centres and the consequences this will have for investors and developers, e-commerce is expected to have a number of other effects on real estate markets. The emergence of pick-up points is one of them. The impact on the retail real estate market itself is much discussed and not the subject of this paper. The general conclusion is that the impact differs by type of retailer or product. Some shops will definitely disappear from the streets, as their products are easier purchased online. For products where the look and feel are important features in attracting consumers, the online and physical retail channels appear to strengthen each other. This is also displayed by the fact that e-commerce retailers are opening physical shops. Such multichannel retailing is becoming a new standard, but the demands on the location and type of retail unit are becoming more strict. Labour market The availability of labour is an essential factor for the location of an e-fulfilment centre. The immediate availability of flexible workers is necessary due to the typical peak traffic in e-fulfilment processes. An additional requirement is good access by public transport, also in the evenings. Such locations are to be found directly near cities and in the western Randstad conurbation. Established logistics hubs that are more access to labour, such as for example Maasvlakte or Moerdijk, are therefore less suitable for an e-fulfillment center. Type of distribution centre Staff per sq m floor space Low volume distribution centre ~ 1 per 1,000 sq m Traditional distribution centre ~ 1 per 500 sq m High volume retail distribution centre ~ 1 per 300 sq m E-fulfilment (peak) ~ 1 per 100 sq m Logistics and E-commerce 13

Conclusion E-commerce logistics is a growth market which only stands at the beginning of its development cycle. Most likely, there will be a long-term and increasing need for real estate solutions that handle the processing of consumer orders in distribution centres. This does not mean that traditional distribution solutions are set to disappear. Rather, e-commerce has created a new segment that will exist next to traditional operations, albeit with an increasing market share. E-commerce involves more and, particularly, more complex processes than traditional distribution, as the split of the commercial and physical channels is leading to profound challenges in the supply chain. These have to be matched by the e-fulfilment centre, which is essentially the most complex form of warehousing available. This means that building specifications are no longer a sufficient tool for identifying logistics property. It is firstly necessary to understand and measure the interaction of the basic functions of storage and distribution. Although there is no one size fits all when it comes to e-fulfilment, it is a property segment that in terms of location, quantity and quality of space has to meet a number of basic requirements. E-fulfilment centres are, therefore, use-specific but not user-specific. The extra demand for space is a very important requirement, which to a large extent can be met by mezzanine floors. The access to a sufficiently large pool of flexible labour is also essential. As e-commerce has changed the traditional standard for logistics processes, in-depth specialist knowledge is required to determine the appropriate logistics solution for a specific product or user group. The realisation of e-fulfilment centres depends on this knowledge, both from the side of the logistics and e-commerce parties as from real estate parties such as investors, developers and lenders. There is a long-term interest which brings these parties together. High-grade sites and e-fulfilment solutions with a mechanised lay-out require a high level of investment. This commits the end-user to the project for the longer term. Although the project is use-specific the risk is limited, as on the one hand the end user is known and involved in an early stage, and on the other hand the need for e-fulfilment solutions will increase due to the further growth in e-commerce. This long-term perspective makes it possible to achieve a solid return on investment. For real estate investors, this provides an opportunity and a valuable diversification of the portfolio. Research findings e-fulfilment centers Location factors 1. In the consumer market. 2. Proximity network hubs and/ or depots. 3. Proximity workforce that is sufficient, flexible and employable. Quantitative space 1. Larger space requirements in floor area of warehouse space. 2. Larger office space requirements. Qualitative space 1. Lower requirements regarding the constructive object specifications. 2. Higher requirements regarding the quality of the space, installations and facilities. 14 Logistics and E-commerce

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For more information about this publication please contact: CBRE B.V. +31 (0)20 626 26 91 netherlands@cbre.com www.cbre.nl Dries Castelein Senior Director Industrial & Logistics Machiel Wolters Director Research & Consultancy