W H I T E PA P E R
Cost Justification of a Warehouse
Management System: A Five Step Plan
Introduction
Executive Summary
Warehouse management systems (WMS) have become essential
to the smooth and efficient operation of complex warehousing
and distribution environments around the world. Advances
in computing, radio frequency and software technology —as
well as cost reductions in some of these areas—enable facilities
of all sizes to enjoy the benefits of sophisticated warehouse
management systems. Much of this advanced functionality
was previously affordable only to larger warehouses and
distribution centers. A key aspect in the evaluation of a WMS
for any implementation, large or small, lies in understanding its
components and benefits, and in justifying the investment of
time and money.
Recognizing the need for a WMS is a straightforward exercise
for many warehouse managers. Inaccurate inventories and
pressures to continually reduce costs make the investment
decision almost intuitive. Investments, however, are rarely made
based on intuition. Fortunately, the benefits of a WMS can be
identified and, to a great extent, quantified, in order to provide
an accurate basis for justification.
The Five Step Plan
Step 1: Define the Problem Areas
Four principal benefits can be expected to arise from the
implementation of a WMS. These benefits lie in the four areas
that cause the majority of efficiency problems in warehouses,
including:
1. Inventory Accuracy
2. Resource Management
3. Customer Service
4. Visibility
With these in mind, the process of justifying a WMS begins
to take shape. The first step is to identify the main problems
currently experienced. Begin by creating a matrix using these
four benefits as the primary categories. Next, list the facility’s
problems under each category. Usually, the person responsible
for managing the warehouse will be best placed to come up
with a definitive list of challenges. However, to ensure that
all problems have been identified, other stakeholders of the
warehousing process should be asked for their input. Open-
ended questions about problems and solutions are often
the most useful: “What is your biggest time killer in picking
an order?” or “what do our customers (internal and external)
think about our current level of service?” Common problems
occurring under the heading of inventory accuracy may include
excess inventory, lost product, and mis-picks. Under resource
management, problems may include wasting time looking for
material, inefficient pick paths, and no means of measuring
performance. Customer service problems often include ship
errors and delayed shipments. Finally, information management
problems may include stock-outs, false stock-outs, transaction
update delays of hours and days, and data entry errors.
 A Five Step Plan

Step 2: Estimate the Costs Step 3: Estimate the Savings

Once warehousing problems have been documented, the
next step is to estimate the costs associated with each. This
step is critical to understanding the severity of any problems.
A variety of equations and industry standards can be used to
quickly estimate the costs. Four examples of typical costs are
listed in Table 1. Having completed a quick estimate of the
costs, it becomes easy to identify the most urgent problems—
those problems that represent your biggest cost factors. The
first example indicates the impact of shipment errors. Two
calculations are made: one assuming a shipment accuracy of
98.5% and one assuming 96%. Shipment accuracy above 95% is
often thought of as excellent, yet the cost of errors in these two
cases is significant—$33,750 and $90,000 respectively.
These costs must be broken out in detail, providing critical
evidence to obtain budget approval for the WMS.
After identifying the major problems within the warehouse
and calculating their cost to the company, the next step is to
put some realistic estimates on how much money a properly
integrated WMS will save. At this stage, it is tempting to
overestimate the money a WMS will save, and to underestimate
the time frame in which it will do so. One way to safeguard
against overestimation is to calculate two to three levels of
potential cost savings — conservative, moderate, and liberal.
The most appropriate level of savings depends on current
operational efficiencies. With current inventory accuracy of
85%, moderate to liberal savings could be expected in many
areas. If inventory is already 99.9% accurate, the savings
estimates should probably be conservative to moderate. Table
2 shows just eight common areas of potential cost savings. The
ranges of savings are based on broad industry approximations.

Table 1 - Cost of Errors

Occurrence Cost/Occurrence Total Cost

Ship Errors 1.5% $45 $33,750
4.0% $45 $90,000
(assume 50k orders/yr.)
Shrinkage .01 x $1M in inv. $10,000
1.0%
.01 x $7M in inv. $70,000
Data Entry Errors 4.0% $10 $40,000
(assume 100k trans./year)
Lost Product 5.0% $31,250
$2.50
7.0% $43,750
(10 minutes searching x $15/hour)
(assume 50k orders x 5 lines/order)
 A Five Step Plan

Table 2 - Potential Cost Savings Consider the following simple scenario:

Picture a warehouse as an inventory pipeline. A company that
Potential Cost Savings
turns $10 million of inventory 20 times a year has an annual
Labor Utilization 10-35% inventory flow of $200 million or a daily flow of approximately
Inventory Reduction 5-30% $500,000. Assume that, through the use of a good WMS,
Floor Space Utilization 10-30% inventory accuracy is near perfect and order cycle times have
Maintenance 0-10% improved. With these improvements, assume that two days
Shrinkage 50-75%
of inventory can be removed from the pipeline. The company
realizes a one-time $1.0 million inventory reduction. The annual
Rolling Stock 10-20%
savings (from the reduction in carrying costs, which are at 35%)
Increase Shipping Accuracy to 99% +
is $350,000.
Increase Data Entry Accuracy to 99% +
Realistically, during the few months of implementation, cost
savings will not be maximized due to “learning curve” issues
Let’s look at specific cost savings examples. Labor utilization
such as training and a reengineered warehouse culture.
can be measured in a number of different ways. One common
However, over time, users should expect near perfection in
measurement is the cost of warehouse labor as a percentage of
those areas that were once major problems. Estimated cost
revenue. Prior to the installation of a WMS, one JDA customer
savings should take into consideration the fact that year two
spent close to 3% of revenue on warehouse labor. A year after
will return greater savings than year one. Time plays a major
implementation of their WMS, labor costs had fallen nearly a full
role in the justification of a WMS. The objective should be to
percent (a savings of approximately $450,000), while their sales
plan for the learning curve and minimize it. It is also important
had increased by close to 30%. The WMS allows more to be
to identify a realistic implementation schedule, weighing the
done with fewer resources.
risks of a shorter schedule against the opportunity costs of a
lengthier one.
The wish to improve inventory accuracy is another prime
reason to invest in a WMS. Inventory reduction and just-in-
Minimizing the learning curve can be accomplished through
time requirements have forced manufacturers and distributors
training (commencing long before implementation) combined
to re-think traditional inventory management philosophies.
with good internal communication (change management).
Accuracy levels exceeding 99% are generally required to
One great way to ensure the implementation schedule remains
achieve world-class service levels, and this must be achieved
realistic is to decide up front on the deliverables and schedule
within a competitive cost structure. Unless inventory accuracy
milestones. The scope of work should not be allowed to grow
is above 99%, it is extremely difficult to reduce stock levels with
without a good reason—the sooner the system is up and
any degree of confidence.
running, the sooner the company starts saving money and
realizing a return on its investment. Time can be saved, and risk
The savings associated with the reduction of inventory levels
minimized, by selecting a flexible and proven WMS product,
may themselves justify investment in a WMS. Many companies
rather than paying for extensive modifications on a baseline
have reported reducing inventory levels by as much as 30%.
system.
This level of reduction greatly affects carrying costs, which
typically equate to 25% to 35% of the cost of inventory.

Step 4: Determine the Cost of a WMS
At this point in the process, it will be reasonably clear how
much money and time a good WMS product will be able to
save. The next step is to determine how much will have to be
spent to integrate the system. Although vendors use various
pricing models, the components of their pricing proposals
usually fall into five categories.
These are license fees, custom development (if applicable),
computer hardware, radio frequency hardware, and services
such as design, implementation, training, testing and travel.
Your internal costs to implement the system should also be
included when defining the total cost of the implementation, as
well as the cost of maintenance over the time period for which
you are calculating the ROI.
An alternate pricing and implementation model may also be
considered. WMS systems are now available on a Software
as a Service (SaaS) basis. In this model you typically pay a
modest up front implementation fee and then have a single
monthly payment (including system and hardware costs and
maintenance fees) for a specified period such as 3 or 5 years.
Add the sum of the payments for the life of the contract and the
implementation fee to determine total system costs.
Although the price of a solution is important, there are other
important criteria that should be considered when selecting a
vendor including track record, size, and the level of trust and
confidence between vendor and customer.
A Five Step Plan
Step 5: Calculate the Return on Investment
A number of financial tools are commonly used to justify
capital expenditures. These vary in complexity from a simple
break-even calculation to a comprehensive computation of
net present value (NPV). Naturally, the more comprehensive
the calculation, the stronger the case that can be made in
requesting funding.
The NPV calculation compares the price of the WMS to the level
of future savings that it will provide. One simple example of
an NPV consideration is to consider whether you would rather
have $100 today or $120 a year from today. NPV considers the
time value of money. To arrive at an answer in this example, you
would have to decide how much interest could be earned in a
year on the $100. If you could earn more than 20% you would
accept the $100 today because your earnings after one year
would be greater than the $120 you would otherwise receive.
To calculate the NPV on an investment in a WMS, several pieces
of information are needed. First, determine the total cost of the
system. Second, calculate the annual savings for at least the first
four years after implementation. Finally, determine the rate of
return required by the company on capital investments. Let’s
look at an example.
Assume you spend $300,000 today for a WMS that will provide
estimated savings of $100,000 in the first year and $150,000
in years two to four. Remember, these are the savings you
calculated in step 3. Also remember, that the present day value
of these savings is less that $100,000 and $150,000 respectively.
Your objective in calculating the NPV is to determine the value
of those annual savings today and compare it to present day’s
cost ($300,000).
Assume your management requires a return of 15% on all
capital investments. At 15%, the first year’s savings of $100,000
is worth $86,960 present day. Present day value $150,000
savings for years two through four is $113,415, $98,625, and
85,770, respectively. Add the total savings in today’s dollars and
you get $384,770. Because the total saving in today’s dollars
($384,770) is greater than the total price of the WMS ($300,000),
the investment can be justified.
 A Five Step Plan

Summary About JDA Software Group, Inc.

The Bottom Line
Competitive pressures are driving warehouse operations of all
sizes to improve inventory accuracy, resource management,
customer service and information management. Advances in
technology and WMS products have driven the price of systems
down. By following a sound, methodical approach, even small-
to medium-sized operations can justify the investment required
to keep pace with their competition.
JDA® Software Group, Inc., The Supply Chain Company®, offers
the broadest portfolio of supply chain, retail merchandising,
store operations and all-channel commerce solutions to help
companies manage the flow of goods from raw materials to
finished products and into the hands of consumers. JDA’s
deep industry expertise and innovative cloud platform help
companies optimize inventory, labor and customer service
levels. As a result, JDA solutions have become the standard for
the world’s leading retailers, manufacturers and distributors.

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06.14.13