Redesigning the supply chain for Internet shopping Bringing ECR to the households

Redesigning the supply chain for Internet shopping Bringing ECR to the households Jan Holmström Kari Tanskanen Vesa Kämäräinen Department of Industrial Management Helsinki University of Technology Abstract Internet shopping is generally considered to grow in the future, however, the forecasts about the growth rate vary a lot (US Department of Commerce, 1998; OECD, 1998). So far the main focus in electronic shopping has been on the marketing, ordering, and paying processes. Logistical processes have most often been based on the existing distribution structures causing additional costs to the consumers. In this paper we argue that the major restricting factor for the growth of electronic shopping is physical distribution and supply chain management. Internet shopping facilitates significant redesigning of the entire supply chain from the factories to the households. It also enables expanding ECR (Efficient Consumer Response) systems to the households by changing the logistics control principles. Leading edge companies in the electronic grocery shopping sector such as Streamline and Homeruns are already experimenting with new kinds of supply chain configurations. Keywords: E-commerce, Logistics, Supply Chain Management, Efficient Consumer Response (ECR) 1. Emerging e-grocery business models Until recently electronic grocery shops have offered extra value for customers only by doing home deliveries. However, this is not enough if electronic grocery shops want to reach the critical mass of consumers. This critical mass of consumers is looking for cheaper prices as well as better service. This has led to the situation where almost every electronic grocery shop has had to reevaluate their roles. Customer service is still important, but low expenses have taken a more important role. Furthermore, the word service does not mean only home deliveries any more. There are a lot more aspects of service than home delivery in the electronic grocery. Customers appreciate things such as delivery window, easy way of receiving and wide product range. This has led to a situation where we have two different ways of operation in the electronic grocery markets. First, we have electronic grocery shops that offer home deliveries as intermediators in the supply chain. Second, we have electronic grocery shops that offer good service, but also cheaper prices for consumers. This second group of electronic grocery shops have created a totally new channel between manufacturers and consumers. Based on the pioneering e-grocery businesses two basic strategies for e-groceries can be identified: the intermediary model, where the e-grocer offer consumers home delivery from local supermarkets the channel model, where the e-grocer creates a new channel that replaces the local supermarket with home-delivery from a distribution center

There are many differences between the two business models. Table 1 lists the most important. Role / mission Mode of operation Difference Intermediary model Channel model Home deliveries as an extra service, from retailer or wholesaler Intermediary Customers purchase (quick delivery) 2 Integrate role of wholesaler and retailer To create new channel between manufacturers and customers Customer inventory management ( enough Value offering point products ) Delivery frequency Order fulfillment, Replenishment, fixed order anytime delivery frequency Final dispatch point Retailer / wholesaler Local distribution center Customer relationship Occasional / regular Regular customer customer Products Brands A lot of private labels Expenses High variable costs, low fixed Low variable costs, high fixed costs costs Prices for customers High Low Goal High customer service High customer service and low prices for the customers Table 1: The main differences between the intermediary and channel model We have two good examples of these different business models. The first one is Peapod, Inc. (www.peapod.com) which is the leading Internet supermarket in the US. The company provides home deliveries in eight metropolitan markets and serves about 100 000 customers (Peapod, 1999). Its strategy has been to take over the markets rapidly. Peapod has taken advantage of the existing supermarket infrastructure and therefore this way to work requires a relatively small capital investment to start (Macht 1996). Peapod has worked many years in cooperation with local retail partners such as Jewel-Osco and Safeway. This is why we can say that it has operated as an intermediator in the electronic grocery markets. Peapod did not own warehouses, instead it picked products from the Jewel-Osco or Safeway supermarkets. This is not very cost effective, but it is a strategy that allows you to quickly move into new areas and cities. Thus, it is a fast way to increase sales volume. The weakness in Peapod s service is receiving of the products. Customers have to be at home to accept the delivery, which is a major restriction for many customers. The second example is Streamline, Inc. (www.streamline.com) which provides regular home deliveries of groceries and other goods and services in the Boston suburban area. Streamline purchases groceries straight from manufacturers and importers. Product are not filled out of existing stores, but rather out of the company s own Consumer Resource Center (CRC) (Dagher 1998). Streamline s operations are built only to serve internet shopping. Because the CRC is not designed for shopping, picking and packing are faster and easier to do than in the supermarket. Orders are delivered to consumer receiving boxes, which include three-temperature units. These Streamline boxes are located for example in the customers garage. Streamline has a high service level and furthermore it has created a new channel between manufacturers and customers that have lower variable costs for home deliveries than when delivered from traditional shops. This will reduce the costs of goods sold when sales volume increases. The weakness of Streamline s service is the delivery frequency. Streamline delivers products only once a week, which is not enough for all consumer requirements.

Peapod has noticed that it can not compete against other electronic grocery shops by its current operation mode. It has started to redesign the distribution channel by setting up its own centralized distribution centers. Because the new structure has lower variable costs and the break-even point is at higher level, they are lowering their service fees to the consumer to further stimulate demand (Peapod 1999). We can conclude that Peapods direction is away from the intermediary model towards the channel model. The emerging model still has serious weaknesses, especially regarding tight time windows for the receiving of the products in the household. If Peapod can solve the customer s receiving issue, it can plan better the distribution to the consumer as Streamline does. This can be leveraged for leveling the workloads on the distribution centers and delivery vans. Another important aspect is that if the receiving problem is solved and the value offering point is moved from customer purchase to customer inventory management (replenishment) it also becomes easier to forecast customer demand. This can then be translated in reducing inventory buffers in the whole supply chain. 2. The challenges facing the e-grocery supply chain The Peapod and Streamline cases illustrate different strategies and operational modes for the development of e-grocery in its very early stages. They also show that there are a lot of potential to improve both efficiency and effectiveness, and logistics is one of the key issues for reaching them. This analysis combined with the analysis of the e-groceries in Finland that are all still applying the intermediary model, has lead us to conclude that the following are the key issues for building an effective and responsive supply chain for the e-grocery business: What is the most effective development path from the current retail business to dedicated e- Grocery that minimizes risks and maximizes revenues? How can we leverage business-to-business collaboration to improve the efficiency and responsiveness of the e-grocery supply chain? How does the development of household resource planning applications affect the e-grocery business models? How can a supplier company effectively configure its own business for supporting different retailing models? These challenges need to be addressed in the right order and together. To do this the ECOMLOG research program has been set up at the TAI Institute at the Helsinki University of Technology. The research program coordinates four research projects addressing the above mentioned challenges facing the e-grocery supply chain. The ECOMLOG research program was launched in April 1999, and is to continue until April 2002. In this paper we will discuss the challenges of the e-grocery supply chain in connection with the research agenda and the preliminary results from the research program. 2.1 Identifying a competitive development path for the Finnish grocery business The first objective for the research program is to identify a competitive e-grocery business model for the Finnish market. The aim is to demonstrate how a Finnish retailer, based on the investments made to the current structure of the grocery supply chain, can build up a channel model. The envisioned model is, thus, a hybrid model combining the existing supermarket channel with a parallel home delivery channel. The basic idea of the hybrid model is that the retailer changes a part of the shop to a local distribution center for home deliveries while still keeping also the conventional store. The assortment of the traditional shop is changed so that share of bulk products decreases and the share of special products increases. The home delivery distribution center uses the conventional store also as an inventory for slow moving items. 3

The first results from the research program indicate that the cost for the consumer to shop and take home his own groceries corresponds to 20 percent of total grocery sales in Finland (Yrjölä et al., 1999). This calculation is based on the value of free time used for road investments in Finland. The result clearly illustrates the high cost of the current supermarket business model for people who value their time. We shop for you is the key selling argument for current e-grocers in Finland. However, the next step is to define the cost and revenue structure for home delivery, and to identify the conditions for providing the service at no or only a small additional cost. The goal is to determine how a channel model can be realized based on the existing supply chain investments of the retail trade in Finland. The means to do this is simulating home-delivery under different demand and product offering conditions. To identify the management and technological enablers for the hybrid model the operations of an e- grocery distribution center, and distribution fleet are studied in detail. A cost and revenue model for home delivery has already been defined in the project. A simulation model is also being constructed using CAPS software to perform detailed analyses. In the first phase the emphasis is solely on the distribution from the logistics centers to homes in the Helsinki area. Later research project phases will include also the mid- and up-stream part of the physical distribution channel. The simulation analysis compares alternative scenarios. The first simulation model of home delivery, comparing the intermediary and channel model, show that how the goods are received in the household has a major impact on the economics of the business model. A tight delivery window is a major constraint on the efficient utilization of personnel in the distribution center and of delivery vans. Finally, the project aims to launch pilots where the key enabling management processes and technologies are prototyped and tested, together with the participating industry partners. The participating industry partners include a major Finnish retail chain, several consumer packaged goods suppliers, as well as telecom companies, and providers of material handling equipment and services. 2.2 Business-to-business collaboration to improve efficiency and responsiveness in the e-grocery supply chain It has been estimated that collaboration in planning, forecasting, and replenishment between supply chain partners has the potential to reduce pipeline inventory by up to 25 % in the retail supply chain. (www.cpfr.org) Thus, the potential for reducing total supply chain costs through information management is critical for realizing a competitive home delivery business model. The establishment of efficient replenishment practices, such as Vendor Managed Inventory (VMI), between the members of the supply chain is a first step that key players in the Finnish retail supply chain have already made (Holmström, 1998a). However, with the introduction of a retail channel that reaches the consumer household new opportunities emerge in the domain of planning and forecasting collaboration. The objective of the e-collaboration task in the ECOMLOG project is to: leverage the new opportunities offered by a channel reaching the consumer in the household for better supply chain planning and control develop new planning and forecasting tools that supplement the efficient replenishment models currently being implemented in the Finnish retail supply chain A comprehensive study covering the basic scenarios for collaborative supply chain planning and forecasting has started. Based on the specific characteristics of the e-grocery business a control model for running the whole supply chain based on household demand will be constructed. Developing and piloting a new forecasting approach is proposed as part of the e-collaboration task in the first year. Currently industry partners are being approached to participate in the development and piloting. 4

This assortment forecasting approach has been developed to specifically address the logistical impact of changes in the product range offered to the consumer (Holmström, 1998b). The approach enables suppliers and trade customers to collaborate on logistics at a much earlier stage in the demand chain, namely when deciding on what products to introduce or phase out from a category. The prototype will be designed specifically for supporting a collaborative process. The Internet and distributed computing (Corba) will be deployed in the prototype. 2.3 The impact of household resource planning on e-grocery business models Streamline s channel model attempts to provide a replenishment service to the consumer. However, since the household lacks a system for inventory management the supplier cannot take full responsibility for delivering when a product runs out. In the Streamline model the consumer is till required to review and release a weekly order. But, today we are already seeing examples of intelligent household appliances, e.g. refrigerators and garbage bins with barcode scanners. Linking up these appliances to a simple inventory management program would offer the e-grocer an opportunity to do the same for the household as some of its suppliers do for the e-grocer: take responsibility that a selection of products is replenished according to consumption. Different value added services by the e-grocer can be defined depending on what demand processes are covered by a resource planning application in the household. The basic value offering point is to purchase. In this case the household application only covers purchasing over the Internet. If the household resource planning application includes inventory management, then the value offering can be moved to inventory management, and the supplier takes responsibility for replenishing products to consumption. Finally, if a calendar and scheduling functionality is included in the household resource planning application, then the value offering point of the supplier can be moved to planning. Now, the e-grocer could propose to deliver the ingredients for a weekend meal according to a specified recipe in the consumer s recipe book and the number of people invited. Today virtually all suppliers work with a value offering to purchase. But the introduction of Internet and ERP systems has already made offers to inventory management common in business-tobusiness relationships. There is no reason to doubt that the development of household planning applications will not have a similar impact on the business-to-consumer relationship in the e-grocery supply chain. The objective of the ECOMLOG research program is to outline what a household resource planning system would have to cover, to enable e-grocers to design advanced demand-supply chains. By taking Enterprise Resource Planning as a starting point, the requirements and currently available technology for an effective household resource system is examined. For example, how can inventory counting best be solved in the household to enable a replenishment service? 2.4 Configuration of the supplier business model for supporting different retailing models The right supply chain for the different new channels emerging depends on the demand chain of your business partner. To address the challenge of configuring a supplier s business model for supporting different retailing models the ECOMLOG research program aims to develop a systematic approach to identify, based on the customer demand chain, the best value offering point. Demand-supply chain configurations are implemented by formalizing the customer-vendor relationships through e.g. service agreements, and collaboration processes. This activity already now takes place in many companies however in the research program an approach to manage these configurations more systematically is to be developed. The focus is on the outbound side, i.e. configuration between a supplier s customers and the supplier. 5

The first task is the identification of the major potential value offering points based on the demand chain descriptions from each main customer segment and the classification of the major demandsupply chain configurations used. A demand-supply chain diagnostics tool is to be developed that: For operational purposes: helps to determine customer value vs. cost to serve. How to set terms of delivery, availability and planning for a specific customer? For tactical/ strategic purposes: helps to assess how the adoption of new configurations by customers affect overall performance In the research program the demand-supply chain configuration approach is enhanced to determine the impact of customer demand chain, product characteristics and lifecycle on value offering and order penetration solutions. This is to support formalizing service offering definitions for key value offering segments. What does the customer buy including all complementors and what is the supplier value added? How to maximize the value of a specific product in a specific demand-supply configuration? Additionally, best practices examples and an overview of systematic demand-supply chain configuration approaches will also be assembled. 3. Research agenda and projects Electronic commerce brings many opportunities and challenges in the supply chain management area. The first obstacle concerns physical distribution to the household. Especially for grocery retailing the challenge is to find solutions for home delivery that are convenient for the consumer and cost efficient. The initial results of the research project indicate that the key to success is a solution for receiving goods in the household, and building a dedicated local distribution center using existing facilities. The second hurdle is improving business-to-business collaboration in the supply chain. The working hypothesis in the ECOMLOG research program is that using Vendor Managed Inventory for order generation and collaborative assortment forecasting techniques for managing the reorder point and safety stock levels enable improvements in inventory buffering and efficiency upstream in the supply chain. The major supplier companies invited to participate in the program already have experience from VMI, and now expect to take the next step by developing and piloting collaborative planning together with the retailing chain partner participating in the e-collaboration project. As we have seen, the scope of the household resource planning that is available for the consumer determines the value offering an e-grocer can make. Research into this critical development area for advanced value offerings has been initiated together with leading technology and telecom service providers in the C-VOP project. Finally, for supplier it is important to learn how to work with parallel business models. This last obstacle to an efficient and responsive e-commerce supply chain is addressed in the B-VOP project of the ECOMLOG research program. Table 1 summarizes the sub-projects, research issues and working hypothesis. 6

Research issues and working hypothesis Project Intertrade + Simulation project e-collaboration C-VOP B-VOP Issue How can we build up an efficient e-grocery model in Finland? How can we leverage businessto-business collaboration to improve the e-grocery supply chain? What is the impact of household resource planning on e-grocery business models? How can a supplier effectively work with differentiated business models? Working hypothesis Hybrid model: build up a channel business model by transforming hypermarkets to local distribution centers Replenish + pace: combine VMI on distributor level with assortment forecasting on channel format level Household resource planning: intelligent appliances and functional information services need to be integrated before e- grocers can move beyond simple order fulfillment Service offering: the supplier must formalize terms of availability and planning, not just delivery Table 2: Sub-projects of EOMLOG research program. References Dagher, N. (1998), Online Grocery Shopping, 1998 INSEAD, Fontaineblau, France Department of Commerce (1998), The emerging digital economy, U.S Department of Commece, National Technical Information Service, Springfield, Virgina Holmström, J. (1998a), Business Process Innovation in the Supply Chain - A Case Study of Implementing Vendor Managed Inventory, European Journal of Purchasing and Supply Management, Vol 4. No. 2/3, pp. 127-131 Holmström, J. (1998b), Handling Product Range Complexity - A Case Study On Re-engineering Demand Forecasting, Business Process Management Journal, Vol 4, No3, pp. 241-258 Macht, J. (1996), Errand boy, Inc.Magazine, November, 1996,pp 60, http://www.inc.com/incmagazine/archives/ 11960601.html OECD (1998), The economic and social impacts of electronic commerce: Preliminary findings and research agenda, www.oecd.org/subject/e_commerce Peapod (1999), http://www.peapod.com Yrjölä, H. & Tanskanen, K.(1999), An evolutionary approach for developing physical distribution in Electronic Grocery Shopping, Working paper, Helsinki University of Technology 7