Fulfilling omni-channel demand Designing a Distribution Network Module 6 Video 2 Fulfilling omni-channel demand Designing a Distribution Network

Intro Think about some of the products you have purchased this week. How did you take possession of those products? Did you pick them up at a store? Did the company deliver them at your home? What different options do retailers have to get products to customers? That is the role of the retailer’s distribution network. First, we are going to identify the key factors to be considered when designing a distribution network. Second, we are going to discuss several distribution network structures and their strengths and weaknesses. And third, we are going to discuss how omnichannel retail affects the choice of distribution networks.

Factors Influencing Distribution Network Design Distribution encompasses the steps taken to move and store a product from the supplier stage to the customer stage in a supply chain. Distribution can vary dramatically from category to category but also for different retailers operating in the same category. For example, P&G distributes directly to large supermarket chains but smaller stores have to buy P&G products from distributors. Can have a huge impact on a retailer’s profitability Directly affects the costs and also the value that customers derive How can we evaluate the performance of a distribution network? How do different distribution structures affect the value provided to the customer and the costs incurred by the company?

Factors Influencing Distribution Network Design On the value side, the retailer’s distribution choices will affect the value that customers obtain. Response time there is a difference between receiving the product next day or receiving it in two weeks Amount of variety we can get to customers can also be very different for different structures. Consider the variety of books you can find at Amazon versus your local bookstore. Product availability Overall customer experience Time it takes to launch a new product Two elements of increasing importance for customers are order visibility and returnability. Order visibility refers to the ability of customers to track their orders from placement to delivery Returnability refers to how easily customers can return merchandise and to the ability of the network to handle those returns. The distribution network also affects the costs to the company. The cost elements that we will consider are facilities, inventories, transportation and information. These costs are very interconnected. For example, suppose we are designing a network to achieve a high level of responsiveness. For that, we will have to increase the number of fulfillment centers. As we do that, the investment in facilities will increase. The costs of inventory will also increase because we will have to keep products in multiple fulfillment centers. The transportation costs will decrease though, because customers will be closer

Distribution structures We are going to consider three main structures. The main difference between the three structures is where most of the inventory is held. Dropshipping Distribution center storage with direct delivery Retail storage with customer pick-up

Dropshipping “drop-shipping” is manufacturer storage with direct shipping to the customer In this model, the retailer collects the orders but does not hold the inventory. The inventory is held by the manufacturer, who is in charge of shipping the product directly to the customer. Popular model for many online retailers. For example, in Zappos’ early years they relied primarily on dropshipping. You would buy a pair of shoes from them but they would be shipped to you by the manufacturer. Other retailers such as Nordstrom.com carry inventory for most of their products, but use dropshipping for some of their slow moving items. What are the pros and the cons of dropshipping? Inventory costs are low because the retailer does not hold the inventory Facility costs are low too because the product is shipping from the manufacturer Transportation costs can be high because the manufacturer tends to be further from the customer than the retailer Requires investing in information infrastructure to integrate manufacturing and retailer. On the customer value side Response time tends to be longer because distances are longer Easy to offer high availability and high variety because all the inventory is aggregated at the manufacturer Order visibility is harder as the product is not shipped by the retailer Handling returns also tends to be difficult Customer experience may not be the best because the retailer loses some of the contact with the customer For example, if the customer places an order with multiple products from different manufacturers, the customer will probably receive multiple shipments This structure is best for high-value, low demand items, where the inventory savings can be most substantial

Distribution center storage with direct delivery The second type of distribution network uses the retailer’s distribution centers as an intermediate location where inventory is held. When customers place an order, the order is shipped to them from the distribution center. This is the model that Amazon uses, in combination with dropshipping for some of their slower-moving items. How does this model compare with dropshipping? Let’s look at the cost side first. Inventory and facility costs will be higher, because the retailer now holds inventory and uses their own facilities Transportation costs will be lower because distribution centers are closer to the customer markets than manufacturers Information costs are lower because the retailer does not have to share information with the manufacturer On the customer value side Response time will be faster than with dropshipping because of the lower distances Adding variety or improving availability will be costlier because the retailer now has to pay for the inventory The retailer enjoys aggregation benefits from keeping the inventory centralized Customer experience will tend to be better because the retailer is responsible for the shipping. This will also make order visibility and returnability easier than with dropshipping.

Retail storage with customer pick-up The third type of distribution network is the one that corresponds to traditional retail. Under this structure, inventory is mostly held locally at stores. Customers who purchase have to pick up the products from the stores. How does this model compare with the models we just discussed? Let’s look at the cost side first Facilities and handling costs are the highest because the retailer needs brick and mortar stores Inventory costs are also the highest because each of the brick and mortar stores needs to hold inventory, losing aggregation benefits The transportation costs are the lowest, since customers pick up the products The needs of IT are lower because it is not necessary to track orders. On the value side Response time is the fastest if the product is available at the store, because customers pick up the product. Because inventory costs are higher, it is going to be harder to offer high availability and high variety Customer experience can be more directly affected Order visibility is not necessary Returnability is higher than in the other modes, because returns can be immediately sold and customers may find an alternative product. This mode of distribution is best for situations with moderate variety or where customers value immediate gratification

Omnichannel We have introduced the three basic modes of distribution. In an omnichannel setting, these different modes can co-exist and interact. For example, we have customer demand coming from the brick and mortar or online stores, and we have different inventory we can use to serve that demand. The inventory can be in stores, in distribution centers, or at the manufacturer’s. The question then becomes, what is the best way of serving that demand? What inventory should I use? Should I use inventory from the stores? Enabling an omnichannel strategy can be very costly in terms of information technology We need accurate inventory visibility across the different channels If a customer is placing an order online and we are going to use inventory from one of the stores, that requires very reliable real-time information so that we can offer the customer an accurate delivery estimate