Financial market thinking applied to warehousing

This isn’t another article to terrify you on how much data Google has on you, no - the point here is that you’re not the only one asking this question - we all are. It’s the question on everyone's mind, and it does not take long to scan through the search results to see that no one has a clue. The answers are all over the place.

Last December the EU Committee published a report for parliament that concluded it would be best to have everything agreed before the deadline next March otherwise a ‘no deal’ will wreak economic havoc. So far so good but then it went on to say the chances of reaching a deal were slim and suggests extending the deadline. Thank you… Great work… More uncertainty.

David Davis has admitted that the government have done little modelling of the impact of Brexit, and before you think someone should probably do that it’s worth considering why no one has really done it. The answer is how could you? A model needs a set of assumptions that you enter inputs in order to get an output. The problem is that there are too many unknown factors , so no one would is able to decide on the framework of inputs to use, let alone make some sensible assumptions. The room for error is too large so no one wants to even attempt making predictions in fear of looking stupid when inevitably things don’t turn out as predicted.

Everything is up in the air, but because we know that then it makes sense to plan for the known unknowns. It’s basic risk management - and it is the responsibility of every business to be in the business of managing their risks. The way you plan for uncertainties is by building options in to your business model. When things change - whether in your favour or against you - you want to be able to act swiftly and decisively, and quite simply the more options you’ve got the better. You don’t want to be the one caught swimming naked when the tide goes out.

How do you build-in optionality? In financial markets it’s simple - you buy them. They’re literally called options. Options are risk management tools that allow traders to capitalise on an opportunity or get out of a position if the market doesn't go their way. In the City traders usually have a liquid market where they can exercise their options as quick as they want. Speed is key here - the ability to respond to events outside of our control makes all the difference.

In the logistics market we can’t move as fast as the traders in the City due to the real-asset nature of our business, but there are means out there to improve our options. Because warehouses require long-term commitments they are the weak link in any supply chain and as such are therefore the single most important focus point for building optionality.

The solution: flexible warehousing. A marketplace platform like Stowga has more warehouses (i.e. more potential options) than any 3PL because it aggregates thousands of suppliers. It also allows people to search and identify those sites immediately, and provides tools to assess the options. Finally, it allows people to both transact quickly by standardising the process, as well as give the customer the option to end the contract at any time as opposed to being tied to servicing a lease. This is game changing because what you’ve done is financial wizardry: you have turned the fixed, long-term cost of a lease into a short-term variable cost. Not only have you given yourself options to hedge against uncertainty, but you will dramatically improve your underlying economics because the variable model is so much more efficient - you only pay for what you use.

When traders build their models they backtest assumptions against historical data to understand how those assumptions would have played out with the luxury of hindsight. In the warehouse market we can do the same with a very simple test asking the question “if you could go back in time knowing there was an option for flexible warehousing would you still sign the last lease you took?”

The answer would almost invariably be no.

People take warehouses based on sales forecasts. Sales forecasts tend to be bullish, no-one wants to forecast misery. That means people over-buy warehouse space. On top of this, things change. The average lease for a small warehouse is five years, a bigger one ten years. Ten years ago is pre-financial crisis. Five years ago is pre-Brexit. Think how much has changed over that time! Nobody in their right mind would ever go back in time and sign that lease again!

So how will Brexit affect your business? Who knows. But what you do know is that if you set up your business to deal with uncertainty your business will be in far better shape when the inevitable ups and down do come. Companies need to maximise their options.