The logistics of developing large-scale automated warehousing

While many real estate asset classes are going through tumultuous times brought on by COVID-19, one asset class defies that trend and continues to be in high demand by domestic and global investors – logistics assets.

Earlier in the year, the Australian Financial Review reported that there was an estimated $30 billion of investor capital which looked to drive a surge in the development of large-scale automated warehouses in Australia over the next decade. JLL’s 2020 Australian Industrial Investment Report forecasted the value of Australia’s industrial investment market to rise by almost a third from $88 billion to $114 billion by 2024.

Hand-in-hand with this growth, is the recent uptake of automated/high-tech logistics solutions by companies such as Woolworths, Coles and Amazon which has featured in the news with increased frequency.

Contributing factors for this growth

Some of the key contributing factors for this growth are:

Population growth

In the last 20 years, Australia has increased its population by a third. In 2018, Australia’s population was projected to reach 30 million within the next decade. While these figures may be impacted by the short-term dip in immigration as a result of COVID-19 restrictions, it is anticipated that the overall population growth will continue its upward trajectory.

With such population growth comes rapid urbanisation and economic opportunities, as well as an increase in both domestic demand and exports to the Asia Pacific region which has similar growth trends.

Evolving retail and global players

Over the past decade, the retail sector has been undergoing seismic change.   With the rise of global online retailers and marketplace platforms such as Amazon and the influx of established international brands such as Zara, H&M and Uniqlo into the Australian market, the domestic retail sector has seen significant disruption.

A common distinction of these international retailers is their comparatively more evolved retail strategies which aim to provide customers with a highly responsive experience including accurate and up-to-date product availability information, rapid delivery times and efficient customer returns.  All of which point towards the need for an efficient logistics solution.

Technological developments

Increasingly sophisticated technology presents opportunities for companies to reduce costs, increase scale, and improve speed and agility across their entire logistics supply chain. Processes that were previously done manually are now performed by automation technologies almost instantaneously.  

Warehouse management systems keep track of inventory in real time, ensuring stock-levels are topped-up as needed. Autonomous vehicles move pallets, robotics identify and pick items from shelves, and highly-developed order management software ensures orders destined for the same area are despatched together.

Mistakes caused by human error are reduced, and workplace injuries resulting from the operation of heavy machinery are minimised. The efficiencies and benefits automated logistics technology offers continues to grow.

Continuing cost pressures

Most sectors face the pressure of keeping costs low to maintain returns. A prime example of this is the supermarket sector in Australia. The entry of Aldi in the Australian market in 2001 has seen an increase in competition in this sector. Transitioning from the strategy of reducing the cost of goods by applying pressure on farmers and suppliers (which has proven publically unpopular), the supermarket retailers have looked towards automation to reduce operational costs and achieve better returns.  

Recent examples include:

• Coles: $950 million in two new automated distribution centres (DCs) in NSW and QLD. With a further partnership with Ocado to build two automated centralised DCs which is anticipated to boost Coles’ online sales by about $1 billion, double its home-delivery capacity, reduce cost-to-serve and lead to improved profit margins for Coles Online.
  
  
• Woolworths: $560 million in its first automated DC in VIC, and a further up to $780 million in two new automated and semi-automated DCs in NSW.
  
  
• Drakes: $125 million for an automated DC in QLD which can handle 23,000 individual product lines.

This trend is not limited to the supermarket retailers and there are an increasing number of automated DCs across the broader retail and logistics sectors including:

• Amazon: $500 million in a 200,000 sqm automated DC in NSW which will double its capacity.  
  
  
• Jaycar (electronics retailer): $80 million for a 21,595 sqm automated DC to be built in NSW.
  
  
• eStore Logistics (logistics provider for retailers such as Kogan.com): two automated DCs in VIC which will increase its capacity from 105,000 orders a day to 200,000 orders a day, and further plans to expand.

COVID-19

With the onset of COVID-19 and social distancing restrictions which have become the new normal, this has further accelerated the adoption of online commerce.  

Ben Franzi, General Manager for Australia Post’s parcel & express services, notes that ”the group’s e-commerce business rose 80% in the first eight weeks of the pandemic compared with the same period a year earlier.” Data from Shippit, a retail logistics software platform, also recorded Australia’s online sales volumes have hit peaks which are 20% higher than Black Friday and Cyber Monday sales last year.

The above factors have led to an increased focus on an efficient logistics strategy. This in turn has seen an unprecedented growth in logistics assets and particularly, the adoption of automated logistics solutions.  With this trend, coupled with the current challenges in other asset class during the pandemic, there has been a significant shift by institutional developers and investors towards the logistics sector:

• Charter Hall: raised a further $1.25 billion for its largest unlisted industrial fund since the start of fiscal 2021.
  
  
• Stockland: plans to increase the value of its logistics development pipeline and to grow its workplace (business parks) and logistics portfolio to 25 per cent of its total assets by 2024.  
  
  
• GIC: invested a further $366 million to boost its stake in an unlisted logistics property trust with Dexus.

Challenges

While the adoption of automated logistics solutions continues to surge, it is still comparatively new in the Australian market. This can bring unique challenges in the procurement of such a solution.

Land availability

To maximise the returns on what is a significant initial investment, automated DCs are often built on a much larger scale. For example, the Woolworths DC in Victoria is a 70,000 sqm, 45 metre-high bay facility on a 15.9 hectare site.

With a lack of zoned industrial land, especially in markets like Sydney, and low vacancy rates in logistics assets (3.8% in the east coast), the availability of suitable land for DCs which are sufficiently close to metropolitan areas can be a challenge.

A potential solution to this issue is the conversion of large-format retail centres to logistics assets, a trend which has taken place in the United States.  This may be followed in Australia with Dexus purchasing a 25,770 sqm large-format retail centre in Western Sydney in October 2019 with the plans to convert it into industrial property over the next 5 years.

International suppliers

As the uptake of automated logistics solutions in Australia is fairly recent, most of the automated logistics solution providers have been international suppliers (albeit with an increasing Australian presence as more Australian companies seek to adopt automated solutions).

This presents certain challenges:

• the risk appetite for suppliers in Europe and America can be quite different to what is considered ‘market’ in Australia and can require extensive negotiations around key risks such as liability caps and exclusions;
  
  
• with different legal systems, the supplier’s familiarity with Australian or common law legal concepts may be limited, particularly if the supplier is based in a civil law jurisdiction and the parties need to work together collaboratively to address such issues;
  
  
• performance security, which is common in the Australian market both in terms of the usual provisions of such bonds and the requirements for bond issuers, can require extensive negotiations if the supplier wants its trading bank (a non-Australian financial institution) to issue such a bond, and such issuer has its own requirements for such bonds; and
  
  
• jurisdictional issues including the law which applies to the contractual arrangements, enforceability of security (including any parent company guarantees), and dispute resolution processes (e.g. the seat of arbitration and the rules which will apply to such arbitration).

Performance obligations

The primary driver for investing in an automated logistics solution is the performance efficiencies that such a solution promises. To mitigate the risk of such performance promises not being fulfilled, it is essential to document:

• performance requirements including minimum acceptance thresholds;
  
  
• testing and commissioning requirements;
  
  
• performance liquidated damages; and
  
  
• defect rectification processes and any post-installation / maintenance services to be provided.

These issues can be complicated by the fact the solutions are often bespoke or supplier-specific and cannot readily be resolved by engaging another supplier to step in if issues arise.

Technology

A key component to any automated logistics solution is the information technology component that drives it. This technology is becoming more and more sophisticated, meaning that automated logistics projects often involve a complex myriad of licensing and implementation issues.

It is critical that the IT aspects of an automated logistics solution project are considered early on and properly managed both on a technical level as well as within the procurement and services contract.

Key areas which need to be considered include integration of new and existing IT system, data compatibility and migration, software licensing, version control and escrow arrangements, and disaster recovery plans.

Other challenges

Some of the other key challenges we have seen arise with such projects include:

• Compliance with Australian standards or requirements (eg occupational health and safety requirements, and electrical safety standards) as the suppliers may be unfamiliar with these requirements;
  
  
• Interfaces and  integration - including between the technology and any automation work, and the landlord works with any automated systems installation works; and
  
  
• Industrial relations issues particularly where there may be associated job losses as part of the transition to an automated logistics strategy.

Opportunities

While the near-term economic outlook may falter due to COVID-19, there will be continued growth in the logistics sector, and the drive towards automated logistics solutions will continue.

TMI Insight has estimated that that there will be an estimated 3 million sqm of industrial leases due to expire over the next four years. Together with the acceleration in online retailing, this is likely to see the next generation of supply chain transformations, with increased investment in logistics and automated logistics solutions becoming mainstream in Australia.