Limits of using distribution as a competitive edge. Implications for Estonian wood sector companies

Transcription

1 Limits of using distribution as a competitive edge. Implications for Estonian wood sector companies Kalev Kaarna 1 University of Tartu Abstract Main conclusions of recent analysis of wood sector have been that growth and competitiveness can not continue if companies do not find ways to cut costs of production or to move to higher level on value chain. One way of cutting costs is decreasing total costs of usage of the product through decreasing the inventory levels of finished goods. The purpose of this article is to analyze the evidence supporting usage of distribution management as a potential source of competitive advantage for Estonian wood sector companies. Two cases of companies using modern distribution concepts as the source of competitive advantage are analysed. In conclusion, based on indirect information and expert opinion some evidence is found supporting the claim that distribution could be used as a competitive edge on European market if company produces or sells into stock. Introduction Wood sector is one of the most important exporters for Estonia as it is the main stabilizer of Estonian negative trade balance (Varblane et al 2004: ). The main problem of wood sector development and competitiveness lies in the source of competitive advantage. Until recently Estonian production companies export competitiveness originates primarily from low labour costs. Economic developments and joining European Union have increased the labour costs resulting in disappearance of the main competitive advantage. There is some evidence that main reasons for de-internationalization of Estonian manufacturing companies are increase in costs and/or poor performance (Reiljan 2004). Primary solution to stop decrease of competitiveness is seen in developing production capacities for moving higher in the value chain (Ukrainski, Varblane 2005; Varblane et al 2004). One of the constraints hindering such development and creating competitive products in cooperation with clients of R&D institutions is lack of finance. In addition overall capability of Estonian wood sector companies to adopt new technologies is relatively low. (Ukrainski, Varblane 2005) Hence there is a need to find an alternative source for medium term competitive advantage for allowing companies to grow their capabilities to sufficient level for moving to higher value creation. One medium term action suggested is finding a way to decrease costs through cooperating in areas such as transportation, purchasing etc (Eesti 2004). Expanding this suggestion further the cutting costs should not be connected only to costs of producer, but also to costs 1 This paper has been prepared with the support of the Estonian Ministry of Education grant project TMJRI0107 1

2 of user. In literature the main emphasis is not any more on decreasing costs of product or service any more, but on total costs of the usage experienced by client. In a supply chain such additional costs come from ordering process and handling stock. Increase in size of stock in warehouses increases the costs of whole supply chain due to holding up significant amount of cash, decreasing the speed of reaction, and amplifying problems from seasonal demand. Hence, significantly better distribution management may increase export competitiveness and offer opportunities to join more competitive supply chains. The higher Estonian companies want to move in value chains, the more important management of stocks and distribution become. Decreasing the stock level allows to increase productivity in some cases (production capacity is not used to increase stock level, but for producing products demanded now), decrease need for additional workers, solve cash flow and financial problems. During recent years supply chain management, Vendor Managed Inventory and replenishment based logistic concept from Theory of Constraints body of knowledge have become important research areas. Emphasis has been on creating more competitive supply chains and increasing company s capabilities in participating competitive supply chains through efficient and effective stock management. Distribution and stock management through Vendor Managed Inventory concept are suggested also as tools for increasing competitiveness for Estonian companies. (Laiv 2005) In principle there are two ways to manage distribution: fixed quantity, variable period approach, and fixed period, variable quantity approach. The first is the traditional way and the latter is used by replenishment based and Vendor Managed Inventory concepts. The focus of current paper is to determine limits of using fixed period based inventory management concepts as sources for creating medium term competitive advantage. For that reason assumptions of fixed quantity and fixed period based distribution concepts are analysed. Sectorial research regarding used distribution management concepts has yet to be conducted. Therefore case study analysis was chosen to determine the main hyphotesis for conducting distribution management concepts research in wood sector industries. Two cases are analysed. The case of Ormann Grubb was chosen because of documented negative results after implementation of replenishment based logistics solution. Seven years after successfully implementing fixed period based distribution system the company went bankrupt. The case of Alas-Kuul was chosen because the company is one of the few known companies in Estonia who uses fixed period based distribution management and who s implementation has mixed results of success. Although there are other Estonian companies such as AS Kalev (Sarapik 2003), Magnum Medical (Paju 2002, Keskpaik 2001), and Anobion Hulgimüük (Sarv 2003), who s successful implementations of replenishment based logistics and Vendor Managed Inventory have been covered in articles, Alas-Kuul s case gives also information about wood sector distribution management concepts. Alas- Kuul is supplying most of the major Estonian industrial companies and can be a source for 2

3 expert opinion for evaluating Estonian wood sector present distribution management practices. In addition, Alas-Kuul is through its own suppliers aware of distribution management practices of industrial supplies in Europe giving an opportunity to get expert opinion on distribution management practices by European industrial companies. 1. Fixed quantity based distribution management Improving inventory management requires lowering both main costs: the order costs and the holding costs. The order cost represent the one time costs occurring when an order is placed: paperwork, unloading, inspection, and stocking the material on arrival. Order cost is relatively independent of order size, hence creating the incentive to order in large quantities to decrease the order cost per part. The drawback of large quantities is increase in holding costs as parts must be held for longer periods. Inventory holding costs consist of costs such as insurance premiums, cost of space, cost of money tied up in inventory. Decreasing holding costs requires ordering in smaller quantities. The formula for representing the EOQ is following (Silver 1976): 2AD EOQ (1) Vr where EOQ economic order quantity in units D demand rate in units/unit time A the fixed cost in dollars, per replenishment, independent of the requisitioned quantity r - the carrying charge in $/$/unit time V - the unit variable cost in $/unit The economic order quantity is based on following assumptions (Silver 1976, Cox et al 2004): Demand occurs continuously at a constant rate. All of an order is received at once. Price is independent of quality. Supply lead time is zero. Replenishment of one item is independent of replenishment of all other items. There are no constraint on cash and space. In practice several of these assumptions do not hold (Cox et al 2004): Demand is usually not constant but variable. Orders sometimes arrive in partial shipments. Supply lead time is positive. Several orders may be places simultaneously for one vendor. Cash or space may be constrained. Despite these deficiencies most managers still believe that EOQ approach gives a reasonable number to order. Another reason for using EOQ approach is the lack of 3

4 knowledge about alternative simple to use methods for determining order quantity. (Cox et al 2004) Researchers have developed alternatives to EOQ which relax one of the assumptions. One of the most frequently used variations is EOQ model with quantity discounts. If the discounted quantity (Q ) is less than the economic order quantity, then purchasing EOQ number of units is optimal. If discount quantity Q is bigger than Q*, additional calculation must be made calculating the total cost of both quantities and choosing the lowest using following formula (Cox et al 2004): D Q TC S H DP (2) Q 2 where EOQ economic order quantity Q order quantity D demand during one period S single order cost H holding cost per unit during one period P price per unit The EOQ equation assumes that inventory fluctuates between Q* and zero, therefore it is assumed that replenishment is instantaneous. As in reality lead time is usually positive meaning that the replenishment order must be places when there is enough inventory to last until replenishment occurs. This point is known as the reorder point. (Cox et al 2004) One problem of reorder point is that demand is not constant, but reorder point (ROP) is based on average demand. This means that on average, half the time an order comes in before stock runs out and half the time the stock runs out. As running out of stock creates loss of sales or customers the ROP is generally set higher than average demand. Commonly used value for reorder point is the mean plus two standard deviations. Depending on the distribution of demand during lead time, this will result in stock outs of somewhere between 2-10% of order cycles. Since most of the time there is stock left over when order arrives, some inventory is carried year round. This inventory is known as safety stock as it functions to protect the system against stocking out. (Cox et al 2004) Another drawback of reorder point or economic order quantity approach is the need for constant monitoring of entire stock. A way to monitor whole stock continuously is to use electronic point-of-sale devices (bar code readers). As such effort is often too costly for smaller companies, companies use ABC analysis for focusing their orders. ABC analysis is based on the rule that says that 20 percent of part numbers are responsible for 80 percent of costs and vice versa (see table 1). (Cox et al 2004) The purpose of the analysis is to identify A items and focus on them paying less attention to B and C items. Saving in A items will result in most significant improvements in performance. Such analysis can be taken further and A items subgroup inside company s A items can be determined. Such subgroup is named AA. These are about 5% of part numbers 4

5 and 65% of the costs. ABC analysis is used for creating visual monitoring system - two bins - to hold the stock. Bin one is large enough to hold the order quantity. Bin two is large enough to hold the reorder point quantity. On top of bin two is a complete order form. When the first bin is emptied, the second is opened and the order is placed. When the order comes in, bin two is refilled and the remainder goes into bin one. (Cox et al 2004) Table 1. ABC analysis division Category Parts Costs A 20% 80% B 15% 15% C 65% 5% Source: Cox et al 2004 In addition to above mentioned problems classic EOQ type reordering is ignoring the EOQ impact to contribution margin or throughput. In reality, if space and cash are limited, the EOQ certainly has an impact on throughput. In practice companies often have a policy for ordering in quantities giving the maximum discount without considering the impact of such actions on cash and space limits. Sometimes suppliers have a policy of minimum quantities for orders. The negative effects for the buyer in case of either policy might be (Cox et al 2004): Inventory turns are low, Large than needed quantities must be ordered for meeting supplier s minimum amounts or discounts, The budget limits meeting automatic order requirements, Shipping costs must be maintained, There are too many vendors, Some items sell slowly, Some items make up disproportional amount of inventory, Some items are out of stock, Lead times for replenishment are long. In order to maximise the discount higher than immediately necessary amounts of one item must be ordered. This leads to low turns and to problem that some items sell slow relative to stock on hand. Also, when cash becomes a constraint due to large stock levels, there isn t enough money to automatically order items when their reorder point is reached. This might lead to running out of stock of these items. Seasonal market escalates the problems listed above. (Cox et al 2004) The core of EOQ problems can be expressed as a conflict (see figure 1). The conflict is presented using a conflict diagram (also called evaporating cloud), which is a Theory of Constraints analysis technique. The diagram consists of five entities: goal, two requirements 2 needed for fulfilling the goal and two conflicting prerequisites assumed to be necessary for achieving requirements. Two requirements are not in conflict, but are both 2 Prerequisites are also called needs, requirements are also called wishes 5

6 necessary for reaching the goal. The conflict diagram is read from left to right using wording In order to [entity], one must [next entity], because [assumption]. Behind every connector of two entities are several assumptions. On the figure 1 only some assumptions are relieved. The solution for the conflict is found by invalidating on or several of assumptions. Usually assumptions connecting requirements and prerequisites can be invalidated, sometimes also assumptions putting prerequisites into conflict. Some of the assumptions might be erroneous, some require changes in current practices. Such idea for invalidating an assumption is called an injection. An implementation of an injection should create a situation where both requirements for fulfilling the goal are achieved without having to achieve one or both of the prerequisites. Figure 2 should be read as follows: in order to minimize inventory costs (goal A), one must minimize holding cost per part (requirement B). In order to minimize holding cost per part (requirement B), one must order in small frequent batches (prerequisite D), because we own the inventory and incure its costs (assumption 1). There are several ways to invalidate listed assumptions. Some of them can be invalidated by using fixed time period systems. Assumption between B-D: 1. We own the inventory and incur the costs 2. Consumers purchase products in small amounts 3. Business clients use products in small amounts Requirements Prerequisites Goal A. Minimize inventory costs B. Minimize holding cost per part C. Minimize order cost per part D. Order in small, frequent batches D Order in large infrequent batches Assumption between D-D : The term batch in D is the same as batch in D Assumption between C-D : 4. Order cost per cycle is fixed 5. Much data needs to be considered for optimal ordering making ordering a time-consuming process which can be done only infrequently 6. Suppliers are unreliable and have long lead times 7. Transportation costs for large batches are significantly lower compared to small batches Figure 1. Conflict of ordering using EOQ. (Cox III et al 2004, Kendall 1997) 6

7 2. Fixed period based distribution management Fixed period and variable quantity system is usually called the periodic review system, where inventory is reviewed on a fixed cycle. Order quantity is based on the amount that has bee sold since the previous review. Based on EOQ formula a periodic review formula can be found (Cox et al 2004): 12Q * RP (4) D where RP review period Q* - economic order quantity in units D demand in units Periodic review does not have to occur only after EOQ is supposedly consumed. The systems philosophies would suggest a short review period (weekly for example) and making and order based on last periods sales. Theory of Constraints based replenishment concept defines following variables for stock monitoring (Yuan et al 2003): Green buffer buffer level for satisfying demand at peak. Red buffer safety buffer level below which timely replenishment is not possible. Replenishment time (R LT ) time required to replenish the order and includes transportation time only. Emergency replenishment time (R ELT ) the shortest time required to replenish the emergency order. Order review period (P CT ) the regular time interval between the reorder points determined by demand and replenishment time. Monitoring window (MW) time interval that functions as a reference for tracking the buffer consumption status and deciding which action to take. Regular replenishment order quantity (R q ) replenishment order quantity at each reorder point. The order quantity is determined by two conditions: if the order review period exceeds the replenishment time, then the quantity the replenishment order is calculated as green buffer level minus current buffer; if the order review period is shorter that the replenishment time, then the quantity of replenishment order is calculated as green buffer level minus current buffer minus schedule on hand. Emergency order quantity (R eq ) the emergency replenishment order placed when the buffer consumption penetrates into the safety buffer level. The amount of the emergency replenishment order is calculated as (green buffer level + current buffer)/2. Green and red buffer determine the sensitivity of the system. If red buffer is too low or too high, the wrong action is more likely to be signalled. Therefore monitoring the buffers consumption is essential. 7

8 Alternative to full time based concept is hybrid system. In case of hybrid system, inventory is checked on a periodic basis and an order is places for those items found to be below the reorder point. In cases of fixed time order points following improvements for clients have been identified (Cox et al 2004, Uuetalu 2003): 1. holding costs decrease, 2. costs of handling orders decrease due to lower time, manpower, and equipment requirement, 3. determining the quantity to order may be done quickly by examining the previous week s sales slips or data, 4. ordering costs become negligible as ordering and receiving actions are taken by the clerk when s/he has spare time on pre-specified day, 5. ordering weekly frees up cash and space for adding more items to the shop, 6. cycle stock and safety stock value are decreased, 7. supplier can usually ship small quantities from stock instead of starting producing or ordering from distribution centre, 8. throughput increases due to increase in stock variety and decrease of stock outs. Several of these improvements have been identified also in cases of Estonian companies, who have implemented Vendor Managed Inventory concept (Uuetalu 2003). In case of Vendor Managed Inventory supplier is responsible for stock, constantly monitors the stock and determines together with the client the safety stock. Yet, in itself Vendor Managed Inventory does not have to be fixed time order point based. 3. Cases of fixed period based distribution management Ormann Grubb case 3 Orman Grubb, founded in 1977, was a Californian manufacturer of contemprorary oak, home office, home entertainment and bedroom furniture making about 35 milion dollars sales annually in early 1990s. In 1994 the owner of the company started the change of existing logistics system by collecting problems from customers based on Theory of Constraints concepts. Three main problems relating to distribution were identified. All of them are more specific versions of general distribution conflict presented on Figure 2. Orman Grubb clients specific problems were: Stores could not determine and hold optimal inventory levels, which resulted in constant cycle of going from too low inventory to too much inventory, Ordering from many suppliers is time and resource consuming, Decreasing fright costs is more tangible target than maximizing sales due to decreasing stock outs. The first problem was boosted by seasonality as stores overestimated customer demand at peak times, ordered too large inventory, then stopped purchasing until inventory was 3 Ormann Grubb case is based on Kendall (1997), unless referenced differently 8

9 decreased significantly. As a result of ABC inventory logic, 80% of inventory reduction was in 20% of the items selling the most. This resulted in being out of stock of most popular items. Being out of stock influenced the stores the most during low season, as stores were not able to maintain reasonable sales level due to lack of most popular items. The second problem forced stores to organise ordering into bigger batches and order infrequently. Such buying pattern created gaps in product lines at stores and clients were often not able to find the whole set of furniture from the store. Clients either did not buy or the store had to make extra deliveries or orders to fulfil client s wishes. The third problem forced stores to order in large batches even if they knew the consequences of infrequent orders (stock outs and lack of cash). Large batches were also preferred as suppliers were relatively unreliable and had long lead times. Therefore stores had to forecast over longer period and order based on that forecast. Ormann Grubb managers developed following solutions for solving clients problems hindering them from improving the performance: Instead of 6-10 week delivery times 16 day deliveries were guaranteed. Make ordering process very simple by allowing to place the order based on sales in prior seven days, resulting in stock replenishment in a 2,5-week cycle. Only monthly or quarterly reassessment is required. Allow making less than a truckload orders at no extra cost to customer and consolidate orders in factory. These changes resulted in liquidating gaps in store stock and increase the sales. Following results were documented within less than a year: Distributors sales increased between %, Inventory turn over for Orman Grubb items was almost 25 turns, 37 new distributors started selling Orman Grubb items, Price is much less of an issue to stores as long as differences are in reasonable range, Orman Grubb could start picking dealers, Debts of stores have decreases as paying smaller bills frequently is financially more suitable for stores, Competition did not react nor did they try to copy the solution. Such advances lasted until Due to the recession sales at key accounts declined and at least three major retailers went bankrupt. In addition much cheaper Asian imported furniture in Orman Grubb key segments started to penetrate the market. Orman Grubb did not react to changes in competitive environment until (Edmonds 2004a, 2004b). Then several steps were taken (ibid 2004a): company moved from large factory building to smaller one, producing components of furniture were outsourced for decreasing prices, four new collections were developed for its core categories, several less profitable furniture groups were dropped, the number of materials used in products was decreased, 9

10 prices of items were decreased 10-20% in order to get closer to 50$ price difference with cheaper Asian merchandise (items sell for 600$-1000$), point-of-sales tagging was developed for informing customers that producer is from California. In March 2004 CEO of Orman Grubb s was very self-confident and announced that We think we have a business model that works. We re going to win. (Edmonds 2004a) Yet in June 2004 the company applied for Chapter 11 bankruptcy protection and started to lay off the last 300 workers. (ibid 2004b) From this case gives some evidence that time based order point replenishment or vendor managed inventory can give on consumer markets an advantage to a company if its products are not significantly higher priced than quality products. In case of Orman Grubb the critical price difference was passed, when Orman Grubb products became more expensive than 20% compared to Asian products. In addition this case study indicates that company s successful in implementing distribution systems and having no immediate reaction from existing companies can stop improving their systems and also become blind to changes in the market place and react slowly. It took Orman Grubb three years before they started reacting to commoditisation of their main product lines. There is some evidence that company did not use the six year competitive advantage window they gained from novel distribution system. Only in 2003 they started to develop new product lines and decrease the costs of production. Alas-Kuul case 4 Alas Kuul is Estonian company was formed in 1993 and is selling machines and components to industries, and offering maintenance of machines. It competes in four areas: baring, industrial gear units, compressors and welding. In 1998 market share in first three sectors was 40-45% and in the welding sector 15-20%. Competition summed up to different major competitors. Market share of closes competitors was around 10-15% of specific market. Alas-Kuul has its offices and warehouses in four major cities in Estonia. Its clients are most of the major businesses of Estonian industrial sector. In 1999 after Russina market crash and 36% decrease in operating profits Alas-Kuul analysed the problems of their clients regarding distribution using Theory of Constraints concepts. Following six problems were the most common: Suppliers don t react fast enough to clients requests; The clients must pay for components that are not used at the moment; Sometimes components will be delivered late; Sometimes gaps in stock create the stoppage of work, which causes loss of production/sales; The purchase function must make extra work and pay extra money in order to get needed components on time; 4 Alas-Kuul case information is gathered from interviews made between with company CEO Indrek Orro. Company s income statements and balance sheets are also used. 10

11 Usually the stock of components is larger than needed. Alas-Kuul found four company policies which amplified the problems: Sales policy belief that the best way to sell industrial products is to use product focused approach and salesmen specialised on some specific product group. Batch policy the bigger is the one time sale, the more the salesman should be awarded. Also, the bigger is the order, the more discounts the client should get. Inventory policy belief that the best way to offer fast deliveries is to have full warehouses in all cities they operated in. Also, the stocks should be ordered based on forecasts of future demand. Clients had to order based on their forecasts. Service policy client is solely responsible for improving their purchasing department s performance. The client is responsible for determining the optimal amount of products to be ordered. Sales policy limited the communication with clients to a minimum and gave no opportunity to identify client s needs outside specific product group. As most salespeople were competent only in one group of components, they could not answer client s questions about other components availability, prices or quality. This decreased sales personnel credibility as problem solvers. Hence, the information flow between the client and Alas Kuul was mainly limited to price and quantities. The second policy assured that salespeople tried to sell as big batches as possible and were not motivated in creating of a smooth stock flow by small and frequent orders. The batch policy motivated also the clients to order in big batches infrequently. Inventory policy made clients to believe, that ordering in big patches is less risky as their predictions were not precise. As a shortage of a component could cause the stoppage of production or loss of sales, the clients were willing to order bigger batches than needed. This resulted in increasing inventory, and money was for a long time tied under the stock that was not needed at the time. Increasing debts to supplier, making extra orders from different suppliers for filling the gaps in stock were direct results of these policies. The reason for accepting these problems was the service policy a client is responsible for their purchasing department s results. If the purchasing department can not forecast precisely how much items they need and run suddenly out of stock, it is their problem. After understanding the source of the problems, Alas-Kuul decided to take responsibility for client s purchasing department s results. In order to do that several changes were made: Central warehousing Instead of four whole warehouses one central warehouse and three intermediate warehouses were created. Instead of forecasting supplying intermediate warehouses and clients is based on replenishment, and on stock flow and buffer management. Delivery service Components are delivered to clients for free. Usual replenishment cycle is one or two weeks, but if necessary delivers can be made also two times a day. Discount based on year sales Discount is not any more based on the size of one order, but the amount bought throughout the year. Client buys with full price during the 11

12 year and gets the discount back at the end of the year. Segmenting market based on their needs Full analysis on clients problems and unsatisfied needs. Although main problems could be identified, not all of them were equally relevant to all clients. Even in same sector company needs could be very different. Internet-based information system Information system offers to client manager fast access to specific information about the client and products, and offers to a client a real time information about the stock. Different roles for personnel instead of product based seller the roles of client manager, product expert and salesperson were created. Business risk salary and owner s profit sharing Business risk salary means that all employees have a chance to invest 10% of their salary for 6 moths with yield up to 300% if stated goals are met. Owner s profit means that at the end of the year, if Alas Kuul profit has increased as planned, all employees are included into dividing the share of profit. Last year 15% of profit was divided among all employees. During first year after implementation in 2000 Alas-Kuul experienced following results: 36 of main clients out of 40 signed long term supplying contract, Alas-Kuul revenue increased 25%, operating profit 46%, Alas-Kuul inventory decreased for the first time in their history, Communication between a client and Alas Kuul had a meaning and a content, Fire fighting due to gaps in stock became almost non-existent, Workers were motivated in finding new ways how to increase company s profits, Development of first successful offer encouraged to do to similar analysis for machinery maintenance service and develop new offering to the market. In addition to these advancements, the cash flow problems were decreased significantly, clients debts decreased, growth of operating expenses slowed down (see table 2). Stock was divided into buffer stock, which was replenished by time based order points, and flow stock, which was not hold in the warehouse and was ordered from international suppliers when clients needed them. In addition, in some cases of new clients they started to hold inventory at client s warehouse. This basically means that instead of four regional warehouses Alas-Kuul has several more. Despite such increase, the buffer stock at central warehouse made 15 turn overs per year, which was a significant increase from 7,4 turns at Yet the same problem of becoming overly self-confident materialised. During 2001 Alas- Kuul started implementing new stock management software without paying any attention to potential effects to revenue, inventory and operating expenses. As a result of poorly planned development and implementation the software automatically increased the inventory levels (2 million kroons of unnecessary stock), the gaps in inventory increased, the operating expenses increased, number of clients using internet based purchasing system decreased significantly. Only at the end of 2003 Alas-Kuul could solve all the problems of information system and get the main warehouse buffer stock to pre-implementation level. 12

13 In addition, it turned out that not all clients knew how to measure the benefits of replenishment based system (starting point level was not determined), several clients purchases of industrial supply were too small for replenishment based system to have any effect. Table 2. Performance measurements of Alas-Kuul Measurement\year Inventory change 59% -11% 6% 10% 6% 17% Inventory turnover 11,2 7,4 10,4 10,2 10,5 11,8 9,9 Turn over of main warehouse 13,3 12,8 Revenue margin 30% 28% 29% 30% 29% 30% 29% 27% 24% Revenue change 64% 66% 6% 25% 4% 14% 19% -2% Contribution margin (throughput) change 57% 67% 12% 19% 9% 9% 13% -16% Operating profit change 162% 110% -38% 46% 9% -13% 47% -72% Operating profit change compared to % -38% -9% -1% -14% 26% -65% Clients'debts change 17% -10% 43% 29% 19% -29% Cash change 168% -31% 71% -32% 91% 153% Return of operating profits 5% 7% 9% 5% 6% 7% 5% 6% 2% Operating expences change 39% 52% 34% 13% 9% 16% 5% 3% Source: authors calculations based on 2004 financial reports Even more, on the bearrings market Alas-Kuul main products became commoditised by competitors starting importing high quality and low cost bearrings. The initial effect of clients evaluating Alas-Kuul service higher than competitors low cost deteriorated rapidly. Competitors incresed in size and revenue faster than Alas-Kuul. In addition, their margins were higher (see table 3 and 4). Although not all competitors revenues are fully from markets where Alas-Kuul competes (table 4), relative change can be detected. Table 3. Margins, profitability and size of industrial bearrings suppliers during Return on operating profit Revenue margin Revenue compared to Alas-Kuul revenue Company\Year Alas-Kuul 6% 2% 27% 24% 100% Balti Laager 1% -0,1% 28% 25% 39% Westward 23% 8% 47% 44% 20% Kavial 21% 24% 38% 37% 11% Katomsk 16% 10% 40% 34% 11% Varson Kaubandus 5% 6% 23% 25% 4% Moduator 12% 5% 38% 37% 3% Comparison: Mecro 6% 8% 25% 23% 502% Comparison: Magnum Medical 5% 6% 10% 10% 903% Source: authors calculations based on 2004 financial reports 13

14 Alas-Kuul took several steps of changing the principles they followed (see table 5). The main changes influencing the revenues and profitability include selling off consumer branch of the company in 2003 (loss of sales about 3-4 millions), and decreasing about 20% the prices of bearrings in The latter step is considered as an investment project with two year payoff. Table 4. Principles Alas-Kuul changed or plans changing during Year 2000 Principle or assumption changed Clients are responsible for their purchasing departments performance Ordering should be done based on fixed quantity system Every local warehouse is independent profit center responsible for assuring optimal stock levels Clients should be motivated to order large quantities 2001 Account manager is motivated by bonuses based on improvement of clients performance results In case of some investments (software) it is unimportant to evaluate the impact on revenue, 2002 inventory and operating expences Client is able to measue the impact of replenishment based ordering to the performance indicators Alas-Kuul can successfully supply business and consumer clients 2003 All clients value buffer management and replenishment equally All sales representatives are able propose successfully to client s management team a change to buffer management and replenishment logistics Every client should have one account manager Only client s management team approval is required for successfully implementing buffer management at client s warehouse Alas-Kuul must store and handle stocks (packing, compiling) itself if they want to be successful 2004 suppliers Alas-Kuul current stock handling team has to be on Alas-Kuul payroll in order to handle Alas- Kuul stock Value from buffer management and replenishment is always higher than competitors lower prices All salesmen are motivated by team based bonus schemes 2005 Alas-Kuul has competitive edge only in companies with high share of industrial supplies in their inventory Alas-Kuul can make profit only by selling industrial supplies and maintaining machinery 2006 Client has to cover total costs (penalties, loss of sales etc) from stoppage of work from lack of 2007 industrial supplies Source: based on interviews Despite these problems in 2005 Alas-Kuul is in position of becoming one of the most efficient stock management companies in industrial suppliers sector. The company is on track with the target of inventory turns of main warehouse. This is considered optimal as turns over this level require inefficient finetuning. The competitors on the Estonian market are making 1,5 to 9 inventory turns (see table 5). The two biggest competitors (Balti Laager and Westward) are making 2,5-3,4 turns of inventory. This means significantly larger requirements for cash and store space, which also increases the risk of gaps in stock. On the table 5 two companies bigger than Alas-Kuul are also presented. Mecro holds some lines of stock which are competing with Alas-Kuul 14

15 products. Yet their main target is not industry as in case of Alas-Kuul. Magnum Medical is wholesale supplier of drugstores and hospitals with medicaments. Magnum Medical is given as an comparison of successful implementation of fixed time replenishment and Vendor Managed Inventory concepts to prove that even in case of big companies high inventory turns are possible. Of course the specifics of medical sector has to be taken into account before drawing any general conclusions. Table 5. Changes in inventory turn over of industrial suppliers during Inventory turn over Inventory turn over of main warehouse YEAR Alas-Kuul 11,8 9,9 13,3 12,8 Balti Laager 3,1 3,4 Westward 3,2 2,5 Kavial 1,6 1,5 Katomsk 1,7 1,8 Varson Kaubandus 9,2 6,7 Moduator 1,7 1,5 Comparison: Mecro 6,4 7,4 Comparison: Magnum Medical 14,2 14,2 Source: authors calculations based on 2004 financial reports Such low turn overs are also common for industrial companies. One of the actions taken by Alas-Kuul is taking over the store management of some wood sector companies. In their case the store management means whole store and not only some industrial supplies. Current inventory turns are 3-5 in most wood sector companies. In addition, Alas-Kuul has identified that big suppliers of industrial supplies like SKF are managing also their stock not very efficiently making 2-6 inventory turns per year. This indicates that replenishment based distribution is not common in European industries also. Alas-Kuul owners are developing a software and a team for offering replenishment based distribution management to their current suppliers who could benefit significanlty from turns increase from 2 to 20. The new business model is based on success of Netherlands 10 people company which is managing stock of big consumer goods companies in Europe (like Nike Europe) on store level. The current value of stock managed by this company is 8 billion euros. Conclusions Using indirect information following conclusions can be drawn for using fixed time order order point logistics as a competitive advantage of Estonian wood sector companies: There is some evidence that fixed time order point distribution concepts can increase revenues, decrease costs and free up cash of supplier. There is some indication that Estonian wood sector companies do not use most efficient stock management concepts. 15

16 Based on two cases, successful implementors of replenishment based distribution tend to value the solution higher than clients and become blind to changes on the market. Value of replenishment based distribution can give advances in price competition until the price differences are not too large for the clients. In two cases examined it was 20%. There is some evidence that replenishment based distribution is not widely used in European industrial markets and Estonian companies have a window of opportunity. Still, as the information used was indirect and mainly based on one expert opinion no general conlucions can be made at this point and further research is required to determine the validity of speculative conclusions driven from the cases. References 1. Alas-Kuul financial reports Balti Laager financial report Cox III, J. F., Blackstone J. H. Jr., Schleier, J. G. Managing Operations. A Focus on Excellence. I & II volume. The North River Press Publishing Corporation.US, 2003, 1113 pp. 4. Eesti puidusektori konkurentsivõime. Tartu Ülikooli Kirjastus, 2004, 367 lk. 5. Katomsk financial report Kavial financial report Kendall, G. I. Securing the Future. Strategies for Exponential Growth Using the Theory of Constraints. US: St. Lucie Press, 1998, 335 pp. 8. Keskpaik, I. Piirangute teooria põhimõtete rakendamine logistikakeskuses. Ärielu, nr. 10, detsember 2001, lk Keskpaik, I. Piirangute teooria põhimõtete rakendamine logistikakeskuses. Ärielu, nr. 10, detsember 2001, lk Laiv, A. Tihe konkurents paneb firmad varusid juhtima. Äripäev Magnum Medical financial report Mecro financial report Moduator financial report Paju, T. Teravmeelne tootmine. Director, nr. 1, jaanuar 2002, lk Paju, T. Teravmeelne tootmine. Director, nr. 1, jaanuar 2002, lk Orro, I. (Alas-Kuul Ltd. CEO). Authors writings. Tallinn, 10. Detcember Orro, I. (Alas-Kuul Ltd. CEO). Authors writings. Tallinn, 3. February Orro, I. (Alas-Kuul Ltd. CEO). Authors writings.tallinn, 15. January Orro, I. (Alas-Kuul Ltd. CEO). Authors writings.tallinn, 1. December Orro, I. (Alas-Kuul Ltd. CEO). Authors writings. 26. September Reiljan, E. Reasons for De-internationalization: an analysis of Estonian Manufacturing Companies. Tartu University Press, dissertation, 2004, 234 pp 22. Sarv, A. Koostöö tagab logistikas efektiivsuse. Äripäev Silver, E. Establishing the Order Quantity When the Amount Received is Uncertain. Infor, February 1976, Vol 14 Issue 1, p

17 24. Ukrainski, K., Varblane, U. Sources of Innovaton in the Estonian Forest and Wood Cluster. University of Tartu, Faculty of Economics and Business Administration Working Paper Series, June 2005 Issue 36, p Uuetalu, M. Tarnija juhitud kaubavarud aitavad käivet kasvatada. Äripäev Varblane, U., Ukrainski, K., Roolaht, T. Polli, L. (2004) Eesti puidusektori tööstusklastriks kujunemise analüüs ja soovitused klastri arenguprobleemide lahendamiseks Euroopa Liidu kontekstis, Eesti majanduspoliitilised perspektiivid Euroopa Liidus, XII teadus- ja koolituskonverentsi ettekanded-artiklid; juuni 2004; Tartu-Värska, Eesti. Tallinn: Mattimar OÜ, lk Varson Kaubandus financial report Westward financial report Yuan, K-J., Chang, S-H., Li, R-K. Enhancement of Theory of Constraints Replenishment Using a Novel Generic Buffer Management Procedure. International Journal of Production Research , Vol. 41 Issue 4, p