Collaborative Supply Chains (Review of lessons learned from Taylor Randall’s lecture in 2002, and added case studies.) Lo205: 2003

Manufacturer Distributor Consumer Retailers Value chains have always consisted of product flows and information flows. Information flows Product flows Potential for information technology to transform information flows to create new business or streamline old business.

Common Business Propositions #1 - Business built on information content Information flows alone have significant value. Examples: iVillage, web communities. #2 - Direct sales and distribution Eliminate intermediaries Examples: Web Van, eToys, Amazon #3 - Streamlined transactions Automated purchasing functions exchanges Examples: E-bay, Exostar, Ventro Group

4 lessons emerging from the dot.com crash...

They who fail to learn from history are doomed to repeat it. Lesson 1: History shows that innovative business success depends on a solid technological infrastructure.… this takes time.

History Quiz: Who said it and when? “You may go to an average store, spend valuable time and select from a limited stock at retail prices… or have our Big Store of World Wide Stocks come to you.” a) Jeff Bezos - business plan of Amazon.com b) Bill Gates - on retail plans for Microsoft c) Vice President of Wal-mart e-tailing d) none of the above.

History Quiz: Who said it and when? Answer: d) none of the above From Sears-Roebuck Catalog 1915 Catalog regarded by economists as a “radical transformation in the marketing and distribution of consumer goods.”

Richard Sears begins to sell watches to railroad station agents. First large general Sears catalog. Sales Growth History of Sears Roebuck What happened here? High Growth

Tough to deliver goods prior to 1900

The King Road Drag Invention leveled and packed muddy roads. Made auto transportation possible.

Richard Sears begins to sell watches to railroad station agents. First large general Sears catalog. Sales Growth History of Sears Roebuck High Growth D. Ward King invents the “King Road Drag” Sears installs pick and ship plant (10x productivity increase) Congress mandates “Parcel Post” as long as you have good roads So what was the greatest innovation the catalog? or the King Road Drag?

“A lot of people jumped the gun. They tried to skip the first two phases.” Roger McNamee, Integral Capital Partners 2000 Technological change happens in 3 phases: 1. Creation of infrastructure 2. Arrival of enabling technologies 3. Business built on the previous 2

Creation of InfrastructureRoads??? Arrival of enabling technologiesPick System??? Postal Service Construction of businessCatalog Sales home delivery Stage of DevelopmentSears Direct Grocery Delivery Can you identify the key technological infrastructure for your business?

Even when American voters are most angry, they re-elect 88% of their politicians. Vital Statistics of Congress. Lesson 2: Because infrastructure changes slowly old companies still hold power.

Examples of incumbent power: Politicians have political action committee dollars. 3 times as expensive to acquire a customer “on-line” as it is to acquire a customer with physical stores. Over 60% of all traditional retailers had data processing and customer service capabilities before going on-line. In 1925 Sears opened retail stores by 1930 retail store sales had outpaced catalog sales. Incumbent power comes from existing infrastructure.

Richard Sears begins to sell watches to railroad station agents. First large general Sears catalog. Sales Growth History of Sears Roebuck D. Ward King invents the “King Road Drag” Sears installs pick and ship plant (10x productivity increase) Congress mandates “Parcel Post” as long as you have good roads Sears opens first retail stores

Lesson 3: The parameter estimates in e-business plans are so far off, even worst case sensitivity analysis isn’t bad enough…. Incorrect estimates lead to adoption of the unprofitable business models.

Example: Revenue Model for a Campus Intranet Provider Advertising Model vs. Software Model 1 school Advertising Software # Schools 1 Install $250,000 # Users Per School 8000 Maintenance $50,000 Active Usage 65% Sessions/Day 2 Page views/Session 12 Images/Page 4 Days year 180 CPM/1000 views $25 Total Revenue $2.25 M

Example: Revenue Model for a Campus Intranet Provider 1 school Phase I Phase II Actual # Schools # Users Per School Active Usage 65% 65% 80% 50% Sessions/Day Page views/Session Images/Page Days year CPM/1000 views $25 $25 $45 $3 Total Revenue $2.25 M $2.2 B $6.3 B $8.5 M Business Valuation $250 M $500 M ? Under actual numbers software model makes more sense.

Lesson 4: In many cases it is hard to sell the value of improved information flow without the accompanying product flow.

Example: Business to Business Purchasing Fragmented Manufacturers DistributorsHospitals Problem: Fragmentation makes purchasing function too complex (multiple shipments and invoices to track, pricing problems. Opportunity: Use New IT to consolidate invoicing and purchasing function

Example: Business to Business Purchasing B2B Exchange Question: How much is the improved information flow worth? Benchmark: Traditional Distributor gets 17% to 30% margin

New Propositions Use technology to make old infrastructure more efficient. #1 Enhance existing products and services with internet technology. #2 Use technology to reduce costs of coordination within companies. #3 Use technology to reduce transaction costs between business partners.

Summary Lessons from the dot.com crash 1 - Successful businesses built on new technology take time. 2 - Incumbents may be more successful using technology. 3 - Carefully consider the estimates in your business models. 4 - Carefully evaluate the value attached to information flows.

Choosing a business model for internet retailing Lecture by Taylor Randall (2002)

Two basic choices Retailer Wholesaler Customer Wholesaler Customer Retailer What factors influence the choice of supply chain? Inventory OwnershipDrop-shipping

Supply Chain options on the Internet* Primary way company fulfills online orders% of Internet-only retailers From company facility that existed13.9% From company facility that was developed30.6% Drop-shipped30.6% Outsourced8.3% From facility operated by a partner8.3% Electronic fulfillment (software)5.6% Other2.7% *The state of eRetailing Supplement to “eRetailing World” March Drop-shipped 30.6%

“Cheap tricks” Start-up capital: $825, ,000 CD titles available for immediate shipment No inventory Motivating Example: Meet Spun.com

One supply chain type not dominant within or across industries Retail Category CDs General Retailing Hold InventoryDrop-ship CDNow.comSpun.com Amazon Value America

BANKRUPT Business results not consistent Retail Category CDs General Retailing Hold InventoryDrop-ship CDNow.comSpun.com Amazon Value America

Making Supply Chain Choice: Theory Considerations in favor of drop-shipping: Reduced investment into fulfillment capabilities Wider product selection Lower fulfillment cost No inventory obsolescence Benefits due to inventory pooling Considerations in favor of inventory ownership: Higher product margin More control over stocking decisions More control over product offering Avoid encroachment of customers Ease of order consolidation Lower technology investment Hybrid strategy?

Factors Influencing Inventory Choice OwnDrop-Ship Development of Industry Firm Size Product Variety Demand Uncertainty Product Transportation Costs Product Obsolescence Risk Immature Large Low variants Low uncertainty Lower Mature Small High variants High uncertainty Higher

Sample Description Survey of 64 publicly held e-tailers 56 responses, 54 usable responses (84.4%) Between 60% and 70% of e-tailing revenue. Financial data from COMPUSTAT data base Example Companies Amazon.comPets.com Barnes&Noble.comEgghead.com CDNow.comDelias.com Fogdog.comAutobytel.com Webvan.comBuy.com 36 companies choose to hold inventory (67%) 11 bankrupt companies (20%)

Measure of rational supply chain choice Actual Choice Model Recommendation Own Not own OwnNot own Irrational 4 firms Irrational 4 firms Rational 21 firms Rational 17 firms Elected to drop-shipElected to own 01 Likely to drop-shipLikely to own inventory

Irrational supply chain choice is associated with bankruptcy! Probability of Bankruptcy RationalIrrationalDifference Choice * *statistically significant difference Irrational Supply Chain Choice and Probability of Bankruptcy Poor supply chain choice one of factors associated with failure.

Summary  Research results: – theoretically obtained criteria for inventory choice, – confirmed hypothesis empirically, – linked inventory choice and firm performance.

Supply Chain Choice Parameters in Grocery Industry Existing StoreDepot Fixed Costs per Year $20,000 $10 million Picking Labor Per Order $20 $5 Market Trends: 2% of all sales will be over internet $100 per order 20 or 30 times per year. 5% margin on food. 60 items per order $25 delivery charge When do you use a existing store and when do you use a depot?

Case Study: Online Grocery Retailing (by JMD, 2003) In 2000 Jupiter Media Matrix predicted online- grocery sales in 2001 to be 2 billion, and in 2005 to 7 billion in the US market. But there have been many failures: –Streamline.com (2000) –ShopLink.com (2000) –Priceline.com quit grocery service (2000) –Kozmo.com and PDQuick.com (2001) –Webvan and HomeRuns.com (2001)

Case Study: Online Grocery Retailing (by JMD, 2003) Peapod Inc. is now the largest in US. They were rescued from bankrupcy by Dutch supermarket chain Royal Ahold in April They invested 73 mil. Peapod uses a hybrid order fulfillment model: stand alone distribution centers and Ahold’s supermarkets.

Case Study: Online Grocery Retailing (by JMD, 2003) Peapod’s characteristics: –Average customer order is 130 dollars. –They charge 9.95 delivery fee –They had a profit in their Chicago center in 2001.

Case Study: Online Grocery Retailing (by JMD, 2003) E-grocers in Europe have done better Datamonitor analyst think the global market is worth 55 billion by 2005, and the UK market is 9.2 billion of that. Tesco.com is one of the most successful in the UK.

Webvan case (by JMD, 2003) Webvan shut down in 2001 They had purchased HomeGrocer.com for 1.2 billion in They had 750,000 customers, 2000 employees, almost 50% of US market share. They could not turn a profit because of their distribution system. They built 26 high tech automated distribution centers (cost 1 bil.) They hoped to cut 40 labor costs on handling groceries. But they did not have enough orders to cover fixed costs. They lost 5 to 30 dollars per order in operating costs.

Netgrocer.com case (by JMD, 2003) Netgrocer delivers only non-perishable goods and maintain only one warehouse in US. They send packages by Federal Express instead of maintaining a fleet of vans. They are the only e-grocer that can efficiently server both suburban and rural populations. (seniors, students, military). Thier site is visited by million per year. Company sales 25 mil. in Grown 65% since Employs 65. Profitable Aggressive customer acquisition, repeat purchasers, online promotions. Offer hard to find grocery items. Delivered in 24 hours. Peapod is giving it’s package delivery customers to Netgrocer. Netgrocer is also partners with manufacturers like Nabisco, Nestle, Gerber, Parmalat, Mead Johnson.

Tesco.com case (by JMD, 2003) Tesco.com is largest online grocer in world. Has order fulfillment operation to 250 Tesco stores (have 690 stores in UK) can reach 94% of population. Start mil. customers, 70,000 orders per week, 422 mil. in annual sales. (3rd largest portal in UK). Going into other markets: electronics, clothes, wine, baby products. In Ireland, starting in So.Korea. Will enter US market with Safeway food retailer. Also will pay 22 mil. for 35% share in GroceryWork.com and relaunch under Safeway brand. Safeway local stores will handle order fulfillment. Safeway has 1500 stores in the US.

LeShop.ch case (by JMD, 2003) LeShop sales were 6 mil. Swiss francs in % increase over Since they have grown 30% each month. Revenues for the 1st half of 2001 were 5.5 mil. Swiss francs. Average spending is 152 Swiss francs. 16,000 have been customers, 76% make repeat purchases. Bon appetit Group is a 54% major partner. 70 employees. Offer 4500 supermarket products. 400 orders per day. Have a fulfillment center in the Bremgarten region. Store fresh foods and employees select. But they distribute incoming orders to packing zones. The shipping box goes to the packing zone, so employees to not take trolleys through the aisles. They pack orders simultaneously. Use Express Post to send. Charge a delivery fee of 12 Swiss francs.

LeShop.ch case (by JMD, 2003) LeShop sales were 6 mil. Swiss francs in % increase over Since they have grown 30% each month. Revenues for the 1st half of 2001 were 5.5 mil. Swiss francs. Average spending is 152 Swiss francs. 16,000 have been customers, 76% make repeat purchases. Bon appetit Group is a 54% major partner. 70 employees. Offer 4500 supermarket products. 400 orders per day. Have a fulfillment center in the Bremgarten region. Store fresh foods and employees select. But they distribute incoming orders to packing zones. The shipping box goes to the packing zone, so employees to not take trolleys through the aisles. They pack orders simultaneously. Use Express Post to send. Charge a delivery fee of 12 Swiss francs.

Given online grocers in US are struggling, will the web-based home-delivery company ever turn a profit? (by JMD, 2003) Yes – but grocers must focus on high-end markets, limit delivery schedules and make partnerships with bricks-and-mortar grocers. Instead of maintaining expensive inventory and warehouses, Peapod uses Royal Ahold stores (Stop & Shop and Giant Food) for its inventory. Low entry costs, builds cust. base. Tesco also uses local supermarkets to fill orders and not central warehouses. The model that has been working is an existing popular grocery chain builds it’s own online ordering system and uses it’s own stores as the warehouse.

Given online grocers in US are struggling, will the web-based home-delivery company ever turn a profit? (by JMD, 2003) No – Studies have shown that Americans do not like going to the grocery store, but they do not want someone else picking their tomatoes. Roger Blackwell says …also he says, ”You should not try to use the Internet..to compete in an industry where the existing competitors are giants with highly efficient distribution systems.”

Why did Tesco.com become a success while Webvan failed? (by JMD, 2003) Webvan tried to reinvent the whole infrastructure. Wanted to build 26 warehouses costing 35 mil each. The warehouses would have to serve large areas with high order volume to cover costs. Also had to spend on brand building. –Fast expansion –Revolutionary customer –Free delivery Tesco extended its supermarkets with online grocery orders. They had brand, suppliers, advertising, a database of 10 mil. Card club members. They use the store-picking model. They can serve an area of 100,000 people and break even on small volumes. –Slow expansion of infrastructure –Obtain traditional customers –Charge a delivery fee (covers cost of vans and drivers).

What future challenges will Tesco.com face? (by JMD, 2003) They must depreciate costs to their offline business. Growing competition from Sainsbury (UK). They use a hybrid model with 36 stores for building customer base, but also has warehouses (picking centers for delivering goods to customer door). Ocado is the UK version of Webvan. Orcado just uses the warehouse model. Tesco’s success in UK may not translate to the US because the US does not have any grocery chains with national status. Also the population in the US is more heterogeneous, with ethnically diverse demands for goods. This means listing more items to serve smaller groups.

Case Study: Online Grocery Retailing (by JMD, 2003)