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An Analysis of Current Supply Chain Best Practices in the Retail Industry with Case Studies of Wal-Mart and Amazon. com by Colby Ronald Chiles and Marguarette Thi Dau Bachelor of Science in Industrial Engineering (2001, 2004) Georgia Institute of Technology Submitted to the Engineering Systems Division in Partial Fulfillment of the Requirements for the Degree of Master of Engineering in Logistics at the MASSACHUSTS IST OF TECHNOLOGY E Massachusetts Institute of Technology June 2005 © 2005 Colby Ronald Chiles and Marguarette Thi Dau All rights reserved JUL 15 2005 LIBRARIES Signature of Author Signature of Author
J’ ,…………….. …. ………………………………. Engineering Systems Division May 6, 2005 Certified by …………….. Gabriel R. Bitran Nippon Telegraph and Telephone Professor oflanagement Science 1 //l Thesis Supervisor Accepted by ……. If.. (….. …………………. Profess -‘w(‘ Yossi Sheffi Professo”‘o Civil and Environmental Engineering Professor of Engineering Systems Director, MIT Center for Transportation and Logistics ARCHIvvct An Analysis of Current Supply Chain Best Practices in the Retail Industry with Case Studies of Wal-Mart and Amazon. com y Colby Ronald Chiles and Marguarette Thi Dau Submitted to the Engineering Systems Division on May 6, 2005 in Partial Fulfillment of the Requirements for the Degree of Master of Engineering in Logistics Abstract In support of the Supply Chain 2020 Project at MIT, this thesis identifies current best practices in retail industry supply chains, with a specific focus on mass merchandising and internet retailing. Using a survey of current literature for context and industry expert interviews, this thesis assesses the current state of the retail industry and analyzes case studies of Wal-Mart and Amazon. om to illustrate retail supply chain best practices. Topics covered in each case study include supply chain strategy and business strategy linkage, operating models, supply chain design, replenishment and distribution processes, and ongoing supply chain improvement initiatives. Wal-Mart and Amazon. com are found to have very different supply chains in terms of structure and processes, based on their different operating models. However, there are many supply chain themes that are common among the two companies. Both case study companies have supply chain strategies, designs, and processes that clearly support their business strategies.
Additionally, these companies tailor processes to fit specific product and demand profiles, collaborate extensively with supply chain partners, invest significantly in information technology, focus on operational efficiency, and leverage scale to facilitate competitive advantage through supply chain management. Based on the common and unique aspects of WalMart and Amazon. com’s supply chains, we provide recommendations for the potential transferability of Wal-Mart and Amazon. com practices within the retail industry and to other industries. Thesis Supervisor: Gabriel Bitran
Title: Nippon Telegraph and Telephone Professor of Management Science 2 Acknowledgements We would like to thank our thesis advisor Professor Gabriel Bitran for providing the right mix of direction and autonomy and for sharing his expertise and insight regarding the retail industry. We would like to thank industry experts Fred Hajjar of Accenture, Steve Biciocchi of CSC Consulting, Gurdip Singh of i2 Technologies, Christian Koch of SAP, and Harvey Rickles and Cy Wang of UPS Supply Chain Solutions, Mike Spears of Gillette for their insight. We also ould like to thank industry experts who are not explicitly named in this document. From MIT, we would like to thank Dr. Larry Lapide and Dr. Chris Caplice who provided direction, industry expert contacts, and expertise to help facilitate the completion of this thesis. Colby’s Acknowledgments I would like to thank my family and friends that have supported me throughout this experience at MIT. I especially would like to thank my Mom and Dad for their love, as well as their support and encouragement in all my endeavors. Marguarette’s Acknowledgments
I would like to thank my family, friends, and loved ones for all their support that they have given throughout the years. I would like to specifically express gratitude to my mom and dad for all their love and encouragement that has helped me get to where I am today. I would also like to thank my thesis partner, Colby for his effort throughout the entire thesis process. This great experience has been made better with their support. 3 Table of Contents Abstract ………………………………………………………………………………………………………………………. Acknowledgements ………………………………………………………………………………………………………. 3 Table of Contents …………………………………………………………………………………………………………. 4 List of Tables ……………………………………………………………………………………………………………….. 7 List of Figures……………………………………………………………………………………………………………… 1 9 Introduction and Motivation…………………………. 9 1. 1 Thesis Scope ………………………………………………. 1. 2 Motivation ……………………………………………………………………………………………………. 11 1. 3 Methodology ………………………………………………………………….. …………. 11 1. 4 2 Outline …………………………………………………………. 12 14 14 Retail Industry Conceptual Review ………………………………………………………………………. . 1 2. 1. 1 1 Supply Chains and Business Strategy ………………. ………………………………………………. 4 Operational Effectiveness, Operational Innovation and Strategy …………….. 16 2. 1. 2 Supply Chain and Product Fit ………………………………….. 2. 2 Retail Industry Supply Chain Overview ……………………………………………………………. 17 2. 2. 1 General Retail Trends . …………………………………………………………………………….. 17 22 2. 2. 2 2. 2. 3
Supplier and Retailer Collaboration …………………………………………………………… 18 Retail and Technology …………………………………………………………………………….. …………………………………. 2. 3 Internet Retail Supply Chain Overview Internet Retail Supply Chain Importance …………………………………. 2. 3. 1 2. 3. 2 Network Design and Growth Impact on Supply Chain Performance 24 25 …………… 26 2. 3. 3 2. 4 Service Windows: Inventory Liquidity and Delivery Tradeoffs . 27 ……………….. 28
Retail Industry Conceptual Review Summary ……………………………………………………. Traditional Retailing ………………………………………………………………………………………. 3 Retail Industry Overview ………………………………….. 3. 1 30 30 3. 1. 1 3. 1. 2 3. 1. 3 30 Retail Industry Definition …………………………………. Products . ………………………………………………………………………………………….. 1 3 Historical Revenues, Margins, and Employees ……………………………………………. 2 3. 1. 4 3. 1. 5 3. 1. 6 Customer Segments . Retail Channels 33 ……………………………………………………………………………….. …………………………………. 34 36 Top 5 Retail Companies …………………….. 3. 1. 7 3. 1. 8 3. 1. 9 Consumer Spending Trends Retail Supply Chain Trends . 39 …………………………………. 42 …………………………………………………………………….. 43 Retail Industry Drivers …………………………………………………………………………….. 3. 1. 0 Retail Supply Chain Structure ………………………………….. Supply Chain Challenges and Opportunities……………………………………………….. 3. 1. 11 Internet Retailing ……………… 3. 2 Internet Retailing Definition ………………………………………………………………….. . 3. 2. 1 3. 2. 2 3. 2. 3 44 46 4…………………….. 48 Products and Services ……………………………………………………………………………… 50 51 ……………………………………………………………..
Historical Revenues and Margins . 4 3. 2. 4 3. 2. 5 Top Five Internet Retail Companies ………………………………… Customer Segments and Sales Channels …………………………………………………….. Trends and Industry Drivers ……………………………………………………………………… Internet Retail Supply Chain Structure ……………………………………………………… 53 57 58 60 3. 2. 6 3. 2. 7 3. 2. 8 Customer Demographics ………………………………………………………………………….. 58 3. 2. Supply Chain Challenges and Opportunities………………………….. 62 3. 3 Industry Overview Conclusion ………………………………………………………………….. ……. 64 4 Wal-Mart and Amazon. com Case Studies …………………………………………………………….. 4. 1 Wal-Mart Retail Industry Position Case Study …………………………………………………… 65 65 4. 1. 1 4. 1. 2 4. 1. 3 Business Strategy …………………………………………. 66 Historical Revenues, Operating Margins, and Employees …………………………….. 7 Business Units …………………………………………. 70 4. 1. 4 4. 1. 5 Products and Services …………………………………………. Sales Channels …………………………………………. 72 74 4. 1. 6 4. 1. 7 4. 2 Customer Segments ………………………………………………………………………………… 75 Wal-Mart’s Competitive Positioning Over Time .. ……………….. 75 Amazon. com Retail Industry Position Case Study ………………………………………………. 77 4. 2. 1 4. 2. 2 4. 2. 3 Amazon. om Business Strategy…………………………………….. 78 Amazon. com Historical Revenues, Margins, and Employees………………………… 78 Business Units …………………………………….. 80 4. 2. 4 4. 2. 5 Products and Services …………………………………….. Sales Channels …………………………………….. 81 83 4. 2. 6 Customer Segments ………………………………………………………………………………… 83 4. 2. 7 Positioning Against Competitors over Time …………………………………….. 4 4. 3 Case Study Retail Industry Position Conclusion………………………………………. 86 5 Wal-Mart and Amazon. com Supply Chain Case Studies ……………………………………… 5. 1 Wal-Mart Supply Chain ………………………………………. 88 88 5. 1. 1 5. 1. 2 5. 1. 3 5. 1. 4 5. 1. 5 The Health and Beauty Aid Product Segment…………………………………………. Key Competitors and Positioning Over Time …………………………………………. Supply Chain Challenges ………………………………………….
Supply Chain Network Overview …………………………………………. High-Level Vendor Replenishment Process …………………………………………. 89 89 91 93 95 5. 1. 6 5. 1. 7 5. 1. 8 Replenishment Processes – Warehouse, Assembly, Direct-to-Store……………….. 98 Store Level Processes……………… …………………………. 103 Wal-Mart and Technology ………………………………………………………………… 104 5. 1. 9 5. 1. 10 5. 1. 11 5. 1. 12 Vendor and Retailer Collaboration ………………………………………….
Supply Chain Organization…………………………………………. Wal-Mart Transportation ……………………………………………………………………….. Supply Chain Initiatives …………………………………………………………………………. Amazon. com US Retail Product Segment ……………………………………… 106 110 111 11 5. 2 5. 2. 1 Amazon. com Supply Chain …………………………………. 115 115 5. 2. 2 5. 2. 3 5. 2. 4 5. 2. 5 5. 2. 6 Media Segment – Positioning Against Competitors over Time …………………….. 16 Amazon. com Supply Chain Challenges and Opportunities……………………… 118 Amazon. com Operating Models and Supply Chains. …………………………… 121 Amazon. com US Supply Chain Network ……………………………………… Inventory Segmentation within the Amazon. com Network …………………………. 126 129 S 5. 2. 7 5. 2. 8 5. 2. 9 Amazon. com Replenishment and Distribution Processes ……………………………. 131 Amazon. com Intra-Distribution Center Profiling and Processes…………………… 34 Transportation ………………………………………………………………………………………. 142 5. 2. 10 Amazon. com and Technology ……………………………………….. 145 146 150 152 5. 2. 11 Amazon. com Supply Chain Initiatives and Research . …………………………. 5. 3 Supply Chain Case Studies Conclusion ……………………………………….. 6 Business Strategy and Supply Chain Strategy ……………………………………….. 6. 1 Wal-Mart Business Strategy and Supply Chain Strategy ……………………………………. 52 6. 1. 1 Operating Model ………………….. ……………… 153 6. 1. 2 Operational Objectives Balance ………………………………….. ……………………… 153 6. 1. 3 EDLP Enablers ………………….. ……………… 154 6. 1. 4 Continuous Improvement……………………….. 158 6. 1. 5 Tailored Business Processes: Wal-Mart Supply Chain Strategy Linkage to Competitive Strategy …………………………………. . 159 6. 2 Amazon. com Business Strategy and Supply Chain Strategy ………………………………. 161 6. 2. Operating Model ………………………………….. 161 6. 2. 2 6. 2. 3 6. 2. 4 6. 2. 5 Operational Objectives Balance …………………………………. Scale …………………………….. Scope ………………………………………………………………………………………………….. Service ………………………………………………………………………………………………… 162 163 164 166 6. 2. 6 Enablers – Collaboration and Technology ………………………… ………. 167 6. 2. 7 Tailored Business Processes: Amazon. orn Supply Chain Strategy Linkage to Competitive Strategy …………………………………. …………………….. 168 6. 3 Conclusion ……………………………………………………….. Wal-Mart and Amazon. com Supply Chain Commonality ………………………………….. Transferability of Best Practices within Wal-Mart, Amazon. com, and the Retail 169 171 7 Commonality, Transferability, and Future Research…………………………………………… 171 7. 1 7. 2 Industry……………………………………………………….. 175 7. Transferability of Supply Chain Concepts between Industries ……………………………. 178 7. 4 Future Research Proposals ……………………………………………………….. 181 7. 5 Conclusion ………………………………………………………. 182 184 Bibliography …………………………………………………………………………………………………………….. 6 List of Tables Table Table Table Table Table Table Table Table Table 3-1 3-2 3-3 4-1 4-2 4-3 4-4 4-5 5-1 Top 20 Retailers Worldwide …………………………………………………………..
Forrester US Online Retail Sales ……………………. ……………………………………….. eMarketer Online Retail Revenue ……………………………………… ………………….. Wal-Mart Stores, Inc. International Retail Outlets ……………………………………………… Wal-Mart Discount Store Product Line ………………………………………………………….. Wal-Mart SAM’S CLUB Product Line ………………. Percentage of Supplier Sales Dedicated to Wal-Mart in 2003 ………………………………. Amazon. om Sales Growth Percentages ………………………………………………………….. Discount Stores in US ………………………………………………………….. 37 52 53 71 73 7………………………. 74 77 82 94 Table 5-2 Distribution Centers by Product Type ………………………………………………………….. 94 List of Figures Figure 3-1 Retail Growth Percentage………………………………………………………….. 32 Figure 3-2 Single and Multi-Channel Retailers by Percentage ……………………………………………. 5 Figure 3-3 Top 5 Retailer Growth 1998-2003………………………………………………………….. 38 Figure 3-4 Division of Retail Revenue ………………………………………………………………….. 38 Figure 3-5 Growth of Shopping Centers and US Population………………………………………………. 40 Figure 3-6 High/Low Income Bracket Trend…………………………………………………………… 41 Figure 3-7 Collaboration Among Global Corporations………………………………………………………. 3 Figure 3-8 Traditional Retail Supply Chain Structure ……………………………………………………….. 45 Figure 3-9 Total Online Sales Revenue by Company Type ……………………………………………. 49 Figure 3-10 The Impact of Consumer and Supplier Dynamics on Sales in Selected Online Product Categories …………………………………………………………… 50 Figure 3-11 DoC Online Sales Figures ………………………………………………………….. ……………….. 1 Figure 3-12 Internet Retailer Revenues ………………………………………………………….. 57 Figure 3-13 Internet Retail Supply Chain Structure ………………………………………………………….. 61 Figure 4-1 Wal-Mart’s 10 Year Revenue Growth ………………………………………………………….. 68 Figure 4-2 Wal-Mart’s 10 Year Operation Income Growth………………………………………………… 68 Figure 4-3 Wal-Mart Average Inventory Turnover Rate ……………………………………………………. 9 Figure 4-4 Segmented Revenue by Business Unit …………………………………. 7………………….. 72 Figure 4-5 Wal-Mart Retailing Outlets Worldwide ………………………………………………………….. 74 Figure 4-6 Amazon. com Revenue 2000-2004 ………………………………………………………….. 78 Figure 4-7 Amazon. com Net Income 2000-20004. ……………………….. …………………………. 79 Figure 4-8 Amazom. com Inventory Turnover 2001-2004 ………………………………………………….. 80 Figure 4-9 Amazon. om Company, Business Unit, and Products and Services Structure ……. 81 Figure 5-1 Wal-Mart to Vendor Ordering Process Information Flow……………………………… 96 Figure 5-2 Wal-Mart Replenishment Process Overview …………………………………………………….. 96 Figure 5-3 Wal-Mart Warehouse Replenishment Process ………………………………………………….. 99 Figure 5-4 Wal-Mart Assembly Replenishment Process ………………………………………………….. 101 Figure 5-5 Process Differentiation Based on Product Characteristics. ………………….. 114 7 Figure 5-6 2004 Amazon. com US Product and Service Revenue Percentages …………………….. 116 Figure 5-7 Amazon. com Fulfillment Costs as Percentage of Revenue ……………………………….. 120 Figure 5-8 Amazon. com as Intermediary – Third Party Sales …………………………………………… Figure 5-9 Amazon. com US Supply Chain Network …………………………………………………. Figure 5-1 1 Amazon. com DC Replenishment Process ………………………………………………….
Figure 5-12 Amazon. com Distribution Process …………………………………………………. Figure 5-13 Amazon. com DC Inbound Process ………………………………………………………………. 124 129 132 133 137 Figure 5-10 Amazon. com’s Multi-Tier Inventory Model …………………………………………………. 131 Figure 5-14 Picking Methodology Overview …………………………………………………. Figure 5-15 Amazon. com DC Outbound Process …………………………………………………. 40 142 Figure 5-16 Transportation Process …………………………………………………. 145 Figure 5-17 Real-Time Sourcing Assignment ………………………………………………………………… 148 Figure 5-18 Re-Evaluated Sourcing Assignment …………………………………………………. 148 Figure 6-1 Wal-Mart’s Business Strategy and Supply Chain Model ………………………………….. 158 Figure 6-2 Amazon. com Business Strategy and Supply Chain Model ……………………………….. 168 8 I
Introduction and Motivation The following chapter provides the foundation for this thesis. It begins with a scope clarification including a definition of the Supply Chain 2020 research initiative, and this thesis’ position within that overall project. Additionally, this chapter discusses the motivation and methodology behind this paper as well as provides an outline for future chapters. 1. 1 Thesis Scope The Supply Chain 2020 Project is a multi-year project initiated by the Center for Transportation & Logistics (CTL) at the Massachusetts Institute of Technology (MIT).
The major research goal for the Supply Chain 2020 Project is to identify the components that will constitute excellent supply chains in the year 2020. In identifying the strategies, processes, and metrics that will comprise excellent supply chains, Supply Chain 2020 hopes to assist companies in multiple industries in developing strategies to remain competitive in the future. The academic year 2004-2005 is Phase I of the Supply Chain 2020 Project. The scope of the initiative for Phase I is to identify and research excellent supply chains in the aerospace, pparel, automotive, communications, computer, consumer products, distribution, pharmaceutical, resources, and retail industries. Specifically, the scope of this thesis is the retail industry. We will focus on the strategies, operating models, network designs, and supply chain processes that constitute an excellent supply chain in the retail industry. In looking at the components listed above, the existing best 9 practices will be analyzed with respect to how they support and promote the business strategy of the specific companies being analyzed. The retail industry has an extremely broad scope.
Therefore it is necessary to reduce the scope of the analysis to specific segments of retail. This thesis will focus on two segments of the retail industry, mass merchandising and internet retailing. The definition of the following two retailing segments will be explained in the retail industry overview. Additionally, this thesis does not cover grocery, apparel, automotive, or luxury good retailers in detail as they are being analyzed by other Supply Chain 2020 researchers. In order to perform a deep analysis of both general merchandising and internet retailing, the leading company in each of these sub-segments is analyzed.
According to annual revenues, the leading general merchandise retailer is Wal-Mart and the leading internet retailer is Amazon. com. This paper analyzes each of these companies. Wal-Mart and Amazon. com service customers through different distribution channels. Wal-Mart primarily services customers through physical retail locations and Amazon. com services customers through an online storefront with distribution provided by Amazon. com and partner distribution centers, as well as third-party companies. The supply chains that support hese different business models inherently require different supply chain strategies, designs, and processes. Thus, this paper is not intended to compare the excellence of Wal-Mart and Amazon’s supply chains relative to one another. Rather, the aim of this paper is to identify the key components of excellent supply chains that support physical mass merchandise retailing and online retailing environments. We identify these components through case studies of Wal-Mart and Amazon. com to understand how their supply chains reinforce their competitive business strategies. 10 1. 2 Motivation
Supply Chain 2020 hopes to lay out a qualitative framework that companies can utilize to prepare for the competitive marketplace in the year 2020. The motivation for this year’s research on existing supply chain best practices is to provide a foundation for future Supply Chain 2020 research. By understanding existing best practices and their relationship with existing strategies, future researchers and companies can more readily identify logical extensions of strategies as well as compare and contrast innovative processes and technologies of the future to existing capabilities.
Furthermore, the motivation behind the segmentation of retail into mass merchandising and internet retailing is to uncover the different approaches to supply chain strategy, design, planning, and execution within those segments. Identification of best practices in each segment may uncover practices that have transferability within segments of the retail industry as well as transferability to other industries. In this way, the research can assist retailers and companies in other industries in their near-term supply chain initiatives. 1. 3 Methodology
Data for this thesis is gathered through a literature review and interviews with industry experts, including consulting firms, technology providers, third-party logistics firms, partner companies, and academic sources. Some companies that provide data for this thesis do not wish to be named due to their close relationships with the case study companies. No interviews with representatives from Wal-Mart and Amazon. com are performed. Wal-Mart and Amazon. com were contacted but declined to be interviewed for this research. 11 1. 4 Outline
Chapter 2 is an introduction to the major concepts that are prevalent in current research on the retail industry. The retail industry is a large, complex, and diverse industry, and as a result academic and mass media literature is abundant. Therefore, Chapter 2 aims to be a review of the major concepts explored in the existing literature, rather than an exhaustive review of all literature on the retail industry. The conceptual review introduces retail and internet retail supply chains and trends, as well as the importance of linking supply chain strategy with business strategy.
Chapter 3 is a comprehensive retail industry overview. Chapter 3, defines the retail industry, the products and services the industry offers, the evolution of the top five companies in the industry, customer segments and sales channels, industry supply chain structure, trends and industry drivers, and supply chain challenges. The overall retail industry is covered, with a specific emphasis on the mass merchandising and internet retailing segments. Chapter 4 covers Wal-Mart and Amazon. com’s positioning in the retail industry and within their retail industry segment.
An analysis of company financials, customer segments and sales channels, supply chain challenges, and competitive positioning is performed. With an understanding of the retail industry and Wal-Mart and Amazon. com’s relative positions within it, Chapter 5 analyzes the Wal-Mart and Amazon. com supply chains. Wal-Mart and Amazon. com’s operating models, supply chain designs, replenishment and distribution processes, and ongoing supply chain improvement initiatives are discussed. Chapter 6 builds upon the supply chain information provided in Chapter 5 to discuss how Wal-Mart and Amazon. om’s supply chains support their respective business strategies. Chapter 6 states how Wal-Mart and Amazon. com employ supply chain practices that fit and reinforce one 12 another, and discusses how they leverage their supply chains to build lasting competitive advantage. Chapter 7 discusses the areas of commonality in Wal-Mart and Amazon. com’s supply chain practices. It also discusses the potential transferability of Wal-Mart and Amazon. com supply chain practices within the companies, the retail industry, and across other industries. Finally, potential areas for future research are identified. 3 2 Retail Industry Conceptual Review Several sections comprise the review of major concepts in the literature relevant to retail supply chains. The review begins with an inter-industry review linking supply chain practices with business strategy. Then a review of literature concepts specific to retail supply chains is performed. Finally, a specialized review of internet retailing is conducted. Topics covered include alignment of supply chain practices with business strategy, collaboration efforts, use of information technology, and operational effectiveness and innovation. . 1 Supply Chains and Business Strategy 2. 1. 1 Operational Effectiveness, Operational Innovation and Strategy A major concept in supply chain literature is the alignment of supply chain initiatives with the overall business strategy of a company. Porter (1996) differentiates between operational effectiveness and strategy. Porter notes that recent business trends have focused on improving operational effectiveness, which at a generic level involves performing the same activities better than competitors. Conversely, strategic positioning involves performing different ctivities than competitors or performing the same activities differently. Hammer (2004) defines the use of different or differentiating methodologies to perform activities as operational innovation. 14 Hammer notes that operational innovation has been a central component to many great business successes, including Wal-Mart. Wal-Mart has used a steady stream of operational innovation to help support its business strategy of offering consumers lower prices. For example, supply chain innovations such as crossdocking help lower costs which help support price reductions.
Therefore, when looking at supply chain practices, efforts to improve efficiency and cost reduction are not sufficient to differentiate a company from competitors. Operational effectiveness must be aligned within the context of a cohesive business strategy to drive lasting differentiation. One reason that operational effectiveness is not sufficient is that a single best practice in a specific area is easily copied. However, if a set of unique practices are utilized, it is much harder for a competitor to imitate (Porter, 1996).
Hammer (2004) supports this point by stating that operational innovation places the company at a higher level than competitors. As competitors strive to raise their performance to the new level, a company that focuses on continual operational innovation can provide lasting differentiation in performance. Porter (1996) notes that in choosing which activities to perform and which strategy to choose, companies must make and understand tradeoffs. Company image is one reason why tradeoffs arise. For example, if a retailer competes on price, but decides to stock only the highest priced product, there is a conflict.
Another reason for tradeoffs is to improve coordination and control of an organization. By explicitly determining which activities are being performed and how they are being performed, the members of the company clearly understand the company’s direction and can more productively move towards it. Another point that Porter makes is that the activities that a company performs need to fit together and reinforce each other. While many companies have been moving to specific success 15 factors and core competencies, Porter stresses that the fit between all activities is more important to sustainable competitive advantage.
In the context of strategy across all industries Porter reinforces his point that operational effectiveness is not sufficient for differentiation from competitors. Conversely, it is deciding which activities to perform and building a strategic position around that set of activities that has the opportunity to create lasting value. In order to execute the strategy, trade-offs must be made and special attention needs to be paid to ensuring that the set of activities performed fit together and help support that strategy that has been identified.
Thus, when analyzing retail supply chains, it is important to consider not only which supply chain activities that companies employ, but also how those activities fit into the company’s business strategy. 2. 1. 2 Supply Chain and Product Fit Before deciding which specific activities will be employed by a company to improve supply chain performance, one must first determine what type of supply chain is appropriate for a company’s products. Fisher (1997) addresses this topic within the scope of two product families: functional and innovative. In both unctional and innovative environments, the importance of choosing the appropriate supply chain strategies is evident. The difference lies in which types of strategies should employed to manage functional versus innovative fast-moving items. Functional products have predictable demand and typically have low-margins. An example provided in the paper is Campbell’s soup. A supply chain design focused on operational efficiency and cost reduction should be designed to support functional products. Initiatives to improve efficiency, reduce cost, and reduce inventory are appropriate for this type of supply chain.
Innovative products by definition do not have predictable demand. Product 16 differentiation in innovative products typically allows higher margins. Although cost is always an important consideration, the types of costs that should be managed in innovative product supply chains are inherently different than for functional products. A reason for the fundamental shift is that the probability of stocking out and the cost of stocking out are much higher in innovative product environments with more demand uncertainty and higher profit margins.
Therefore, a strategy focused on reducing inventory carrying costs could adversely affect company profitability, because the cost of stocking out is much greater than savings that can be achieved by reducing inventory. Therefore, a supply chain design focused on flexibility and responsiveness to demand fluctuation should be designed for innovative products. This entails strategies focused on deploying the correct amount of inventory in specific locations to respond to uncertainty, reducing lead time, and improving collaboration.
All of these initiatives increase costs in the short-term but are appropriate when matched to a business strategy tailored towards innovative products. 2. 2 Retail Industry Supply Chain Overview 2. 2. 1 General Retail Trends The retail industry can be defined generally as the composition of companies that sell merchandise to customers. When studying the supply chain practices of the retail industry, we study the retailer and customer relationship, which in turn drives the activities between retailers and suppliers.
In retail supply chains, the network consists of many suppliers that serve multiple retailers, and retailers that are served by multiple suppliers. Between the suppliers and the retailers, wholesalers and other intermediaries often reside and provide the link between retailers 17 and suppliers. There have been changes in the dynamics of the relationship between these three key players in the supply chain due to the fourth major player that drives these changes, the retail customer. Through their spending habits, retail consumers drive the level of customer service that is expected.
The strategy behind each retailer is focused on being able to fulfill that demanded service. Because of recent changes in consumer spending, the focus in the retail supply chain has shifted from handling customer demands through inventory levels to handling customer demand through changes in the trading partner relationship and the use of technology in their supply chain. Griffith and Krampf (1997) address some of the trends that are driving these changes in the retail industry supply chain by looking at the changes in the way consumers shop. For xample, consumers are now shopping in retail stores that appeal to consumer convenience and price sensitivity. The time that consumers spend in certain stores is declining; and therefore, retailers are realizing that on-shelf availability is becoming more critical. Due to the change in consumer spending habits, on which we will elaborate further in this thesis, general merchandise stores that include a wide range of product segments are emerging as revenue leaders in the retail industry. These general or mass merchandisers are creating retail stores that provide all merchandise that a consumer needs in one convenient location.
Consumer habit changes are a contributing factor driving retail supply chain changes. 2. 2. 2 Supplier and Retailer Collaboration Traditionally, retailers have mitigated the risk of stockouts by carrying buffer inventory for those items with high demand. Because retailers are now realizing the cost of holding these stocks, there has been a shift in supply chain strategy to deal with fast moving inventory. 18 Retailers and suppliers have become partners in combating the changes in demand variability.
The impact of the bullwhip effect, where suppliers receive a disproportionate amount of variability based on retailer consumer demand variability, has helped facilitate collaborative efforts to better respond to demand fluctuations. both the retailer and supplier. Ellram, La Londe, and Weber (1999) research the emerging trends in supply chain These initiatives are aimed at reducing costs for structure changes in the 1980’s. The concept of Quick Response (QR) enables suppliers to forecast what retailers are going to order before the order is actually made through information sharing.
QR changes the relationship between the supplier and retailer by connecting the two with new technology. The authors show how point of sale (POS) data and electronic data interchange (EDI) changes the communication level between suppliers and retailers. Point of sale data is increasingly important, allowing suppliers to know the actual consumer demand patterns of fast moving items, which enables suppliers to prepare for the next order before the retailer makes the order. The connection between the two entities electronically through the use of EDI allows for quicker information sharing, which then leads to shorter order cycle times.
The major difference between the traditional supply chain and the one emerging during this time is the focus on the interaction between the retailer and supplier, rather than on each entity’s supply chain practices within their own organization. For the first time, retailers and suppliers are sharing demand information that was once known only to retailers. Quick Response signifies the beginning of the collaborative effort, although, at the time of the research, retailers were still the ones who made the decision of how much to order and when.
The results from these trends led to more strategic changes within the supply chain that were seen 20 years later. 19 As suppliers and retailers realize that their upstream (towards the source) partners in the supply chain are able to do activities that lead to cost cutting and better service, more responsibilities are being pushed to partners further up the supply chain. This is especially true in retail companies that sell mass merchandise and have increasing buyer power over their suppliers. The change in responsibilities can be seen in Norek’s (1997) report on “functional hiftability”. In the mass merchandising segment of the retail industry, retailers realize that their suppliers can supply their products in such a way that significantly reduces costs on the retail end. Functional shifts occur when one of the entities in the supply chain partnership has a substantial amount of economic power over the other entities. The more powerful entity is able to push more responsibilities and activities on to the weaker entities, and force the weaker entities to find ways to cut their manufacturing or distribution costs. In Norek’s results, the four ajor activities that retailers are requiring from their suppliers or manufacturers were the storage of raw inventory, various packaging activities, organization of products for delivery, and electronic data interchange. Overall, the initiative is an attempt to participate in global optimization, instead of focusing on local optimization. In global optimization, the retail supply chain is studied as one system that can be optimized through cross-entity functions within the system, to minimize cost and maximize profit for the entire supply chain.
Another supplier and retailer partnership initiative is collaborative planning, forecasting, and replenishment (CPFR). Crum and Palmatier (2004) address the issue of demand collaboration between suppliers and retailers and why the acceptance of collaboration is slow, given that the possible benefits are high. They emphasize the fact that the focal point of reducing uncertainty should be on knowledge of demand. If partners throughout the supply chain have knowledge of demand, then they know what to expect in terms of selling and supplying the 20 demanded product.
This in turn lessens the bullwhip effect that causes high demand variability for partners downstream in the supply chain. Crum and Palmatier (2004) survey consumer goods suppliers and retailers about the possibility of implementing CPFR by 2003, and only 41% of consumer good suppliers and 25% of retailers had any positive indications of CPFR efforts. The reason for the high level of rejection of CPFR is the fact that suppliers find that they continue to incur much of the risk, even when they do have demand information from retailers. This is partly attributed to the fact that ven though retailers have demand information, at the time of order placement, they do not order in the same pattern as demand indicates. The difference between demand information and actual orders force suppliers to fulfill orders that are not expected. Crum and Palmatier indicate that in order for CPFR to be successful, suppliers and retailers must agree on a demand management process and must open communications entirely. Most of the success is based on the trust that the partners have with one another and belief that what is forecasted between the two will be what is ordered to fulfill demand.
When partners collaboratively plan for demand the overall effect should be a more cost effective supply chain. The final retailer supplier collaboration trend that we discuss is the use of vendor managed inventory (VMI). Waller, Johnson, and Davis (1999) maintain that VMI permits cost cutting in the supply chain for both retailers and suppliers, and is also a mechanism that increases customer service level. VMI is an initiative where vendors are responsible for determining retail replenishment levels and managing the amount of inventory that the retailer has on hand. When etailers participate in VMI, they are allowing their suppliers to know the actual demands of their products and provide automatic replenishment at the retailing or distribution facilities. VMI benefits retailers due to more frequent replenishments. This frequency increases the customer 21 service level due to the increased supply chain flexibility to respond to consumer demand and ensure on-shelf availability. The result is increased retailer sales revenue. The supplier benefits from this process because they have full knowledge of demand and avoid high demand variability caused by orders from retailers.
Ultimately, suppliers do their own demand planning and replenishment processes. Because suppliers know in advance the amount of products they need to replenish, they are able to better plan, which then leads to a reduction in inventory levels and a reduction in transportation costs. VMI is only successful when communication and trust is present in the partnership, because both incur risks as a result of sharing sensitive information across companies. Therefore, research uncovers a trend towards closer partnerships and shifts in responsibilities between retailers and suppliers in a variety of activities within the retail supply chain.
The goal for all partners is to globally optimize the supply chain by decreasing the overall costs of supply chain management while maintaining or improving service, and ultimately increasing revenues. 2. 2. 3 Retail and Technology Retail industry supply chain partners are increasing their use of information technology to support and improve their supply chain management initiatives. As mentioned earlier, this trend started in the 1980’s with electronic data interchange and the use of scanning barcodes to keep more accurate track of sales throughout the industry. With more accurate data and a faster way f transmitting these data, information technology has helped increase the speed of activities within the retail supply chain. The ability to respond to customer changes and other sources of supply chain variability has become more efficient with the use of technology. 22 The transfer to a supply chain partnership that is more dependent on technology is due to the increasing awareness that information across partners is important to communication and cost cutting efforts. Kent and Mentzer (2003) explain this trend towards a technology-driven supply chain through the concept of interorganizational information technology (OIT).
IOIT facilitates the information sharing process between partners. EDI is an example of this type of technology that has become familiar in supply chains. Kent studies the effect of the perception of investments on IOIT, and how these investments have impacted the relationship between partners. The results of his studies indicate that the perceived investments in IOIT by the partners in the supply chain increase the trust level between the partners. The investment indicates to other partners that there is a commitment present to optimize the channel.
If the investment amount is low, then the trust level, as well as commitment level, decreases. Investment in IOIT does not only include the implementation of new data transferring and collecting technology, but also the ability to positively utilize the data to optimize the supply chain. Additionally, one of the major projects in retail technology is the piloting and implementation of radio frequency identification (RFID) tags. RFID tags are promised to offer several advantages over barcodes including automatic detection, omni-directional data capture, and increased data storage capacity.
Some believe that RFID will provide “error-free fulfillment, delivery, and visibility” throughout the supply chain (“RFID: Powering The Supply Chain”, 2002). Because RFID tags are able to hold more information than a barcode, as well as hold dynamic information about the product, more detailed item specific information can be stored. The reader that picks up RFID tag information captures data without manual intervention, reducing the need for labor. The article emphasizes one of the major future benefits from RFID 23 technology will be increased product visibility throughout the supply chain.
The increased visibility that RFID tags can provide is promised to provide management with more control over the supply chain. Furthermore, responses to consumer demands and unanticipated events in the supply chain are expected to be faster with the use of RFID. 2. 3 Internet Retail Supply Chain Overview The internet retail industry is a segment of the overall retail industry. The industry consists of existing retailers with physical stores that also sell products over the internet, and companies that do not operate retail stores and utilize only a website to sell products to customers.
The retailers that primarily sell product through their network of physical store locations are commonly referred to as “brick-and-mortar” in retail literature. If these traditional retailers sell product through an online channel, that activity is known as “click-and-mortar”. “pure-play” internet retailers are companies that only sell through product through an online channel. For example, Wal-Mart is a brick-and-mortar company that also operates a website in which they sell products over the internet. Amazon. com is a pure-play internet retailer that utilizes their website as their storefront.
The lack of retail stores in pure-play environments requires a supply chain that can service the needs of customers through a combination of shipping from distribution centers and sourcing from partners. This paper intends to focus on the characteristics of an excellent pure-play internet retailer supply chain. Therefore, research described below will describe the importance of supply chain performance to internet retail success as well as the characteristics of an internet retail supply chain network. 24 2. 3. 1 Internet Retail Supply Chain Importance
Maltz, Rabinovich, and Sinha (2004) discuss logistics and supply chain excellence as critical to success in the internet retail industry. A particular area of concentration in the paper is the positioning of inventory in the different echelons of the supply chain. The increased product selection offered by internet retailers presents an array of inventory challenges. First, internet retailers must decide whether to operate their own distribution centers, ship directly from supplier’s facilities, or leverage the capabilities of intermediaries and wholesalers. Maltz et al. (2004) discuss Amazon. om’s three-echelon inventory system where they maintain their own distribution centers, but also ship product directly from suppliers, and pull inventory from wholesalers to fill orders. Also, the authors discuss the use of consolidated inventory in a few sites and trans-shipment between sites to fulfill demand. The consolidation and trans-shipment approach helps to aggregate demand to reduce variability. However, there is a tradeoff between transportation costs and the inventory carrying costs when deciding how to put together a network and the inventory that is stored at each level.
The effect of catalog management from a supply chain perspective is also discussed by Maltz et al (2004). The paper mentions segregating inventory by the potential margin that inventory could represent and by the velocity of the inventory. In addition to network inventory and catalog inventory management, the Maltz et al (2004) paper discusses physical efficiency as a key component to internet retail supply chain success. Tradeoffs can be made to increase economies of scale and scope in physical distribution. These benefits were seen by Amazon. om with its free shipping initiative. The initiative did increase the transportation costs that Amazon. com absorbed, but it also decreased fulfillment costs from 12. 8% of sales to 10. 6% of sales. The costs decrease due to the efficient 25 distribution that is allowed from a larger number of orders that are consolidated and wholly filled from facilities. 2. 3. 2 Network Design and Growth Impact on Supply Chain Performance To illustrate the importance of network design and physical performance to internet retail uccess, Rabinovich and Evers (2003) focus on improvements in inventory performance and product release performance. Inventory performance has to do with the efficient execution of orders from on-hand inventory at different echelons in the supply chain. Product release performance has to do with the efficient distribution and transportation of orders. The paper discusses the impact that reducing the number of facilities in the supply chain network and increasing market share have on inventory and product release performance. The analysis is erformed with respect to statistical economies, economies of scale, and economies of scope. Statistical economies occur with a reduced number of inventory carrying locations in the supply chain due to the reduction in safety stock. Economies of scale exist when the size and efficiency of larger facilities are able to fulfill orders at a lower cost of orders. Economies of scope involve analyzing the number of entities and coordination between these entities to fill orders. The paper looks at the three-echelon network of suppliers, intermediaries, and internet retail distribution centers.
Results from the paper show that reducing the number of internal facilities in the supply chain and supporting direct distribution helps improve statistical economies and economies of scale by facility. Furthermore, as market share increases, further opportunities for aggregation and consolidation occur which further improve supply chain performance. Therefore, becoming a large internet retailer helps to improve supply chain performance. 26 2. 3. 3 Service Windows: Inventory Liquidity and Delivery Tradeoffs Inventory liquidity is a measure of an organizations ability to fill orders from on-hand nventory and the amount that must be sourced from intermediaries or suppliers. Rabinovich (2004) discusses this concept within the scope of promises that internet retailers offer to customers. Internet retailers make promises regarding shipment and delivery dates to customers during the internet retailing shopping experience. These promises have an impact on sales. There are two components to the promise, the ship date guarantee and the delivery date guarantee. The ship date guarantee is heavily dependent on inventory liquidity.
If the internet retailer can not fill the order from their dedicated distribution center, then they must source the order from their partners. This increases the order-to-ship time. The increased order-to-ship time, can be countered by a shortened delivery time. In this way, the overall delivery date guarantee to the customer can be made with a combination of a higher than promised order-toship time and a lower than promised ship-to-deliver time. In the analysis of inventory liquidity and fulfillment guarantees, Rabinovich discovers that the number of items on an order and the price of items on the order both decrease inventory liquidity.
In fulfilling an order, a distribution center is less likely to have all of the items to ship the order from that single source as the number of items on an order increases. Furthermore, higher priced items cost more for firms to carry, which reduces the safety stock levels they are willing to carry. These findings lead Rabinovich to suggest that firms promote shortened delivery time options as a tradeoff to increased order-to-ship times for orders with many unique items with high dollar value. 7 Rabinovich’s research is another example where a multi-tier internet retail inventory network, profiling, and service window management can be analyzed to improve internet retail supply chain performance. 2. 4 Retail Industry Conceptual Review Summary The analysis to uncover the key components of an excellent supply chain in the retail industry is multi-faceted. The definition of an excellent supply chain differs by company, and is highly dependent on a particular company’s business strategy.
The opening portion of this conceptual review focused on the importance of strategy in evaluating a supply chain, including focus and fit on the activities that differentiate a company from competitors. Additionally, when looking at supply chain practices, opportunities for innovation should be addressed as well as opportunities for improved efficiency. These factors, in addition to understanding the functional or innovative nature of the products being sold, illustrate the ideas that will constitute an excellent supply chain that supports a retailer’s business strategy.
In analyzing the retail industry and the internet retail segment, many areas are taken into account, including collaboration efforts, use of technology, supply chain design, and operational efficiency. An analysis of the current trends in retail show that collaboration is increasing with initiatives such as collaborative planning, forecasting, and replenishment (CPFR) and vendor managed inventory (VMI). Information technology has enabled these efforts and continues to drive increased communication across all parties in the supply chain. An analysis of internet retail illustrated the importance of supply chain to business survival.
An analysis of network design, supply chain echelon coordination, and various inventory and transportation tradeoffs show the complex nature of a supply chain designed to meet internet retail requirements. In 28 summary, strategy, collaboration, technology, operational innovation and efficiency are all essential to maintaining an excellent supply chain in the retail industry. 29 3 Retail Industry Overview The retail industry overview chapter of this paper defines the current state of the retail industry and describes its evolution in recent years. The following overview encompasses the full status of the US retail industry.
Therefore, some of the aggregate retail statistics go beyond the scope of our thesis. However, the majority of the information focuses on mass merchandise retailing within traditional and internet channels, where the case study companies reside. The major topics covered for each segment are product lines, current financial conditions, customer segments, sales channels, trends, major drivers, general supply chain structure, and supply chain challenges and opportunities. 3. 1 Traditional Retailing 3. 1. 1 Retail Industry Definition Generally defined, the retail industry is the composition of retail outlets that sell erchandise to consumers. Retail includes both products and services sold in stores, through catalogs, and through the internet. This definition will be refined through the subsequent subheadings of this chapter focusing on products, sales channels, and financial characteristics. 30 3. 1. 2 Products The scope of the retail industry encompasses products in many different categories. The products that are generally considered part of the retail industry are apparel, consumer product goods (CPG), groceries, entertainment media and other luxury goods such as jewelry and automotives.
Retail also includes services, such as after sale automotive services. Two major areas where current industry statistics and news can be found are through Standard and Poor’s (S&P) Industry Reports and through the United States Department of Commerce (DoC). Both sources include all the retail channels that companies utilize to sell their merchandise to consumers, which include physical stores, internet, and catalog. S&P uses the US government’s definition to more specifically define its product scope. The US government divides products into durable and non-durable goods.
Durable goods are products that are not consumed or disposed of relatively quickly. Durable products include automotives and furniture and products that are found in hardware stores. Non-durable goods are general mass merchandise, apparel, and grocery items. The product focus in the S&P Industry Surveys will be mostly on non- durable goods, and some durables that are sold in general merchandise outlets. Although the focus of this thesis is on general mass merchandise goods that include consumer product goods and entertainment media, the following is an overview of the retail industry as defined by Standard and Poor’s (S&P).
The industry overview will include all products that are sold in the following retail outlets: Department Stores, General Merchandise Stores, Hypermarkets and Supermarkets, and Specialty Stores. The retail outlets can also be divided into high-end retail, moderate retail, and deeply discounted retail. 31 3. 1. 3 Historical Revenues, Margins, and Employees Based on the S&P General Retail Industry report that was released in May 2004, retail sales in 2003 equated to $3. 40 trillion. The industry experienced a 5. 4% growth from 2002, which was associated mostly with the growth in sales of luxury goods and discounted goods.
The National Retail Federation (2004) states that the retail industry had more than 23 million employees in 2004. This represents approximately 20% of the total US workforce. The retail industry makes up 31% of the US Gross Domestic Product (GDP), and thus is very important to the US economy. US retail industry growth has been slowing in recent years, although positive growth persists in all years. In 1999, the US Retail Industry saw a 9% growth from 1998, but since then there has been much slower growth from year to year. 2000 to 2002 only saw a slight change in percentage difference.
It was not until 2002 to 2003 did the percentage growth begin to rise again. The graph on the follow page depicts the changes in percentage growth from 1999 to 2003 for the US Retail Industry (“Mission Statement”, 2004). Figure 3-1 Retail Growth Percentage a C 4) u 10. 0% 8. 0% 6. 0% 2. 0% 0. 0% 1999 I 2000 I 2001 2002 2003 CL 4. 0%- r 0 0 Year Source: Standard and Poor’s General Retailing Industry Surveys 2000-2004 32 Retail Industry growth from 2002 to 2003 can be attributed to two distinct product categories. Those two product categories are luxury goods and goods that are sold in general merchandising or discounted stores.
Luxury goods include designer apparel and jewelry in highend department stores and niche specific stores with strong name brands. S&P correlates the growth in sales for luxury goods to the increase in consumer spending capabilities. The increase in luxury spending is attributed to the general improvement in the economy in 2003 in relation to the economic downturn of 2001 to 2002. In addition to luxury goods, the general merchandise and discounted product groups have also experienced major growth in the past year that is comparable to luxury sales growth. In 2003, the rift widened between consumers with more xpendable income versus more cost conscious consumers. Due to the weak economy from 2001 to 2003, price competitive products offered in discount stores appealed more to consumers. These discount outlets, which are also known as mass merchandisers, include stores like WalMart, Target, and Big Lots. The overall growth of the economy has led to retail industry growth. S&P expects retail industry growth to be higher than 5. 4% from 2003 to 2004. Moderate department stores, which fall in between discounters and high-end luxury retailers, are experiencing the slowest growth in the industry.
The department stores include Federated Department Stores, Inc. as well as other well known department stores such as Kohl’s and Sears. The slow growth in moderate retail outlets can be attributed to the lack of variety in products as well as customer service levels that do not meet customer expectations. 3. 1. 4 Customer Segments Understanding what customers demand and having those products available are vital components of retailing. The S&P Industry Survey for the Retail Industry includes a section 33 entitled “Deciphering demographics. By having a grasp on population growth patterns and customer segmentation, retailers can determine the spending patterns of their customers and adjust their inventory and selling models accordingly. For the most part, consumers born before 1976 have become weaker dr