Distribution Strategies

Jerry Banks

Supply network design

• Centralized versus decentralized control

• Distribution strategies

• Push versus pull systems

Centralized versus decentralized control

• Centralized– Decisions are made at a central location for the

entire supply chain network– Minimizes total system cost subject to service-

level requirements– Global optimization

Centralized versus decentralized control

• Decentralized– Each facility identifies its most effective

strategy– Local optimization

Effect of information

• When each facility can access only its own information, centralized strategy is not possible

• But, information technology makes information sharing possible

Distribution strategies

• Direct shipment– Items shipped from the supplier to retail store without

going through distribution centers

• Warehousing– The classical strategy

• Cross-docking– Items are distributed continuously from suppliers

through warehouses to customers– However, they are kept at the warehouse for only 8 to

12 hours

Direct shipment

• Advantages– No cost for operating distribution centers– Lead times are reduced

• Disadvantages– Risk-pooling effects are negated– Manufacturer and distributor transportation

costs increase because smaller trucks are sent to more locations

Direct shipment

• Used when the retail store requires full truck loads

• Useful when perishable goods are involved– Grocery industry

JC Penney uses a direct shipping strategy

• Sells through 1000 stores and millions of catalogs

• 200,000 items from more than 20,000 suppliers

• Each store has total accountability for sales, inventories, and profits

• Each store is responsible for sales forecasts and ordering

JC Penney uses a direct shipping strategy

• Orders are communicated to buyers who coordinate the shipment with distribution personnel to ensure quick response

• Internal control and tracking system monitors flow of materials

• In most cases, products are shipped directly to Penney’s stores

Cross-docking

• Made famous by Wal-Mart– Warehouses function as inventory coordination

points– Goods arrive at warehouses from the

manufacturer – Transferred to vehicles serving the retailers– Goods spend less than 12 hours at the warehouse– System limits inventory costs and decreases lead

time by decreasing storage time

Cross-docking

• Expensive to start up and difficult to manage– Distribution centers, retailers, and suppliers

must be linked with advanced information systems to ensure that all pickups and deliveries are made within the required time windows

– Must have a fast and responsive transportation system

Cross-docking

• Expensive to start up and difficult to manage– Forecasts are critical – information must be shared

– Effective only for large distribution systems

• Large number of vehicles are delivering and picking up goods at the cross-dock facility

• Shipments of fully loaded trucks every day from suppliers to warehouses

• Large demands exist so full truckloads result

Wal-Mart specifics

• Largest and highest-profit retailer in the world

• 85% of its goods are cross-docked– 50% for K-Mart

• Private satellite communications system that sends POS data to all its vendors

• Dedicated fleet of 2000 trucks• Stores are replenished twice/week

Wal-Mart specifics

• Wal-Mart purchases full truckloads

• Reduced safety stock

• Cost of sales cut by 3%

Questions to answer in groups

• Describe a retail environment that is not amenable to cross docking

• A firm distributes to large urban retailers as well as small ones. If the firm uses cross-docking, does service to the two types of retailers differ?

• If a firm uses cross-docking to reduce inventory holding costs, aren’t they simply pushing the inventory (and safety stock) further up the supply chain? What is the net gain?

RFIDRadio Frequency Identification

RFID• First appeared in 1980s

• Non-contact reading

• Hostile environments

• Wide range of applications– Cattle ID– Automated vehicles broadcasting their locations– Etc.

RFID includes• Antenna

• Transceiver (with decoder)

• Transponder (RF tag) electronically programmed with unique information

How RFID’s work• When an RFID tag passes through the

electromagnetic zone, it detects the reader's activation signal

• The reader decodes the data encoded in the tag's chip and the data is passed to the host computer for processing

Active and passive• Active

– Powered by an internal battery and are typically read/write

• Passive– Operate without a separate external power source and

obtain operating power generated from the reader– Much lighter than active tags, less expensive, and offer

a virtually unlimited operational lifetime– But, they have shorter read ranges than active tags and

require a higher-powered reader

Advantage over barcodes

• Noncontact, non-line-of-sight nature of the technology– Tags can be read through a variety of

substances such as snow, fog, ice, paint, crusted grime, and other visually and environmentally challenging conditions, where barcodes or other optically read technologies would be useless

Growth of RFID technology

• Highly unlikely that the technology will ultimately replace barcode – Will never be as cost-effective as a barcode

label  – RFID will continue to grow in its established

niches where barcode or other optical technologies are not effective

Logistics Today, June 2004

• Numerous articles on the RFID deadline

• The essence of these articles will be discussed

“Wal-Mart holds firm on RFID deadline”

• In early 2003, Wal-Mart sent shockwaves through the entire logistics field when it announced that its suppliers should adopt RFID by January, 2005

• In the past year, any firm with products remotely suggestive of RFID has helped revive the given-up-for-dead technology marketplace

“Wal-Mart holds firm on RFID deadline”

• Now, suppliers are asking for answers

“Wal-Mart holds firm on RFID deadline”

• Will Wal-Mart be reading RFID tags at POS terminals in January, 2005?– No, says Wal-Mart

“Wal-Mart holds firm on RFID deadline”

• Will Wal-Mart be placing readers in every one of its DCs by January, 2005?– No, says Wal-Mart

“Wal-Mart holds firm on RFID deadline”

• Is Wal-Mart slowing down the time table?– No, says Wal-Mart

“Wal-Mart holds firm on RFID deadline”

• Wal-Mart’s intention is to pick one geographic area – a DC, a group of stores – in which to begin

• Wal-Mart’s intention is to have all domestic suppliers compliant by 2006

“Wal-Mart holds firm on RFID deadline”

• Since Wal-Mart announced its RFID initiative, other organizations have announced similar projects– US DoD– Target– Home Depot– German-based Metro– UK-based Tesco

“Logistics executives question benefits of RFID”

• Serious doubts about how firms will be able to achieve any internal benefits

• Sit back and wait mentality

• No way to justify the high cost of US$0.30 to US$0.40 per tag

• It will take time for the RFID initiatives to begin driving cost out of the supply chain

“RFID’s impact on market growth larger than expected”

• Inbound Logistics, May 2004

• The market size and compound annual growth rate was originally estimated to rise by 21% annually between 2003 and 2005

• The near-term annual growth rate for RFID software and systems is now expected to surpass 37%

“Prospective RFID users face supply chain challenges”

• Inbound Logistics, May 2004

• From a US$1 billion market in 2004 to a US$3 billion in 2008

• If the cost of an RFID tag decreases

• US$.50 today, but may drop to US$.05 in one or two years

“Prospective RFID users face supply chain challenges”

• Supply chains with all items tagged, moving and visible will be very positive

• But, done wrong it could be a nightmare

“New FCC rule improves RFID systems used for container security”

• Inbound Logistics, May 2004• FCC = Federal Communications

Commission• Enabling the contents of containers to be

rapidly inventoried will help users determine whether tampering with their contents has occurred during shipping says the FCC

“Cultural problems slow RFID momentum overseas”

• A widespread interest exists, but it appears to be shallow

• Two factors contribute to the reluctance– Technical problems

• Read rates are too slow

• Difficulties in affixing tags to products

“Cultural problems slow RFID momentum overseas”

• Cultural problems– Stronger than the technical problems– Internal distrust and animosity toward the IT

departments– Fear of change within the organization

“Cultural problems slow RFID momentum overseas”

• However, there is a great interest at many levels in RFID adoption

• Belief that there will be some benefit in actual work and return on investment over the next five years

Prediction• If some standards commonality is achieved

- whereby RFID equipment from different manufacturers can be used interchangeably - the market will very likely grow exponentially

What factors influence distribution strategies?

• Customer demand

• Customer location

• Service level

• Transportation costs

• Inventory costs

Interplay between inventory and transportation costs

• Both depend on shipment size– But in opposite ways– Increasing lot sizes reduces the delivery

frequency and enables the shipper to take advantage of price breaks in shipping volume

• Reduces transportation costs

– However, large lot sizes increase inventory cost per item

• Items remain in inventory longer

Demand variability

• Also impacts distribution strategy• Larger the variability, the more stock

needed• Stock held at the warehouse provides

protection against demand variability• Due to risk pooling, the more warehouses a

distributor has, the more safety stock is needed

However, if cross-docking or direct shipping is used

– More safety stock is needed in the distribution system

– Because each store needs to keep enough safety stock

– Mitigated by distribution strategies that enable better demand strategies and smaller safety stocks and transshipment

– Must also consider lead time, volume requirements, and capital investment

Distribution strategiesStrategy

Attribute

Direct

Shipment

Cross

Docking

Warehouses

Risk

Pooling

Takes

advantage

Transportation

Costs

Reduced inbound costs

Reduced inbound costs

Holding

Costs

No ware-

house costs

No holding

costs

Allocation

Decision (to retail outlet)

Made early Delayed Delayed

Transshipment

• Shipment of items between different facilities at the same level in the supply chain to meet an immediate need

• Customers demand is met from another retailer

• Retailers must know what other retailers have in inventory– Information system is needed

Transshipment

• Since all inventories are available, this takes advantage of risk pooling

• If retailers are independently owned, this doesn’t work as well– Helps competitors

Central versus local facilities

• First consideration: Safety stock– Consolidating warehouses allows the vendor to

take advantage of risk pooling– The more centralized an operation, the lower

the safety stock

Central versus local facilities

• Second consideration: Overhead– Operating a few large central warehouses leads

to lower total overhead costs (compared to operating many smaller warehouses)

Central versus local facilities

• Third consideration: Economies of scale– In manufacturing, it is often less expensive to

have one central manufacturing facility than many smaller ones

Central versus local facilities

• Fourth consideration: Lead time– Can often be reduced if a large number of

warehouses exist (they might be closer to the market areas)

Central versus local facilities

• Fifth consideration: Service– Centralized warehousing enables risk pooling

so orders can be met (and with a lower total inventory level)

– But, shipping time from the warehouse to the retailer will be longer

Central versus local facilities

• Sixth consideration: Transportation costs– As the number of warehouses increases,

transportation costs go up because total distance traveled is greater

– And, quantity discounts are less likely to apply– However, transportation costs from the

warehouses to the retailers are likely to fall as the warehouses are closer to the retailers

Push versus pull systems

• Push-based supply chain– Based on long-term forecasts

• Pull-based supply chain– Production is demand driven

Push system

Manufacturer

Product

Retailer

Orders

ExternalDemand

Push system

• Based on long-term forecasts

• Takes time to react to a change in demand leading to– Inability to meet changing demand patterns– Obsolescence of supply chain inventory as

demand for some products disappears

Push system

• Bullwhip effect is more pronounced leading to – Excessive inventories

• Larger safety stocks are needed

– Larger production lots• And more variable

– Decreased service levels

Push system

• Production capacity– Should it be based on peak demand?

• Results in lots of idle capacity

• Transportation capacity– Should it be based on peak demand?

• Results in lots of idle capacity

– Should it be based on average demand?• Results in expensive spot costs

Pull system

Manufacturer

Product

Retailer

Orders

ExternalDemand

Pull system

• Coordinated with actual customer demand– For example, POS data

• This leads to– Decrease in lead times

• Due to better anticipation of incoming orders from the retailers

– Decrease in inventories at the retailers• Shorter lead times decrease inventories

Pull system

• This leads to– Decrease in variability in the system

• Specially, variability faced by manufacturers– Due to lead time reduction

• Decreased inventory at the manufacturer– Due to reduction in variability

Hybrid systems

• Postponement or delayed differentiation– Initial stages of the supply chain are push– Final stages are pull– Interface is called the push-pull boundary– Discussed later

End