Saturday, May 3, 2008

Distribution Options for Retailers

When it comes to distribution, Retailers have many options. These are Direct to Store, conventional Warehouse based “stock and distribute”, or Cross-dock (or flow-through) models. Each of these options affects the supply chain efficiencies and costs. In a previous article on cross-docking, we discussed the process, benefits, and some of readiness issues for cross-docking. The current discussion is targeted to review the costs associated with each of the three options, and a decision support methodology to select the optimal model for distribution.

Distribution Models for Retail

Understanding the costs and having processes to measure these costs provides an objective way to evaluate the impact of selecting these options. Most real-life situations will be complex enough to demand simultaneous deployment of all the three options for differing set of products and locations. But the cost analysis still helps to know what these sets should ideally be.

Following cost elements exist at various nodes and the arcs in the diagram.

Cost Elements Relevant to Distribution

The table below shows the cost elements related to each of the above distribution models. Not all elements exist at all the nodes or supply chain arcs. The table shows where these elements exist, and should be considered in costing the above options.

Some of these costs are harder to measure than others, but almost all of them can be objectively estimated for a good comparison among the available options for the selected set of products.

Cost Element

Direct-to-store

Warehouse (stock & distribute)

Cross-dock (flow-through)

Demand Planning

At the store

At the store

At the Warehouse

At the store

Replenishment Planning

At the store

At the store

At the Warehouse

At the store

Demand Consolidation

NA

NA

Aggregate at cross-dock

Ordering

At the store

At the Warehouse

At the cross-dock

Receiving

At the store

At the Warehouse

At the store

At the cross-dock

At the store

Disposition (after receiving)

NA

At the Warehouse

At the cross-dock

Put-away

NA

At the Warehouse

NA

Storage

NA

At the Warehouse

NA

Transfer Orders or Allocations

NA

At the store (pull based)

At the cross-dock for stores

Transfer Order Fulfillment Planning (waves) or Allocations

NA

At the Warehouse (order waves)

At the cross-dock (distribute using original demand, or allocate)

Picking

NA

At the Warehouse

NA

Packing

NA

At the Warehouse

At the cross-dock

Staging

NA

At the Warehouse

At the cross-dock

Shipping

Supplier to Store

Supplier to Warehouse

Warehouse to Store

Supplier to Cross-dock

Cross-dock to Store

Cost of Inventory

NA (common to all)

At the Warehouse

NA (assuming pure cross-dock, no stocking)

While the cost elements provide good data points for decision making, there is more to be considered.

We will look at the impact of these options on the twin supply chain parameters of lead-time and inventory. It is important to understand the interaction of costs with these two core parameters. For example, a shorter lead-time to replenish the store demand helps in better fulfillment decisions and specially helps when the demand is volatile. It also leads to smaller safety stocks at the stores. But it may also require more frequent and smaller shipments that affect the shipping and receiving operational costs.

Finally we will look at the supply chain processes, and how they get affected in each of the options.

Together this methodology provides a thorough decision support mechanism for selecting the optimal distribution models.

Lead-time and Inventory

Lead-time

We will assume that the lead-time in this context is the total time between the creation of demand at the store and its replenishment. From this point of view, the “warehouse” and the “cross-dock” models provide comparable lead-time efficiencies for the store.

However the “warehouse” model provides an inherent advantage. By maintaining the warehouse inventory, it helps in absorbing the variability in the demand and supply processes; and spares the stores from the effects of demand volatility.

The same is not quite true in the “cross-dock” model as there is no inventory to buffer such effects. Cross-docking models can distribute to stores using the original demand make-up, or by looking at the latest demand and re-allocating merchandise as it is received. While the latter provides a little respite by matching the latest demand against the supply, it still cannot address any system-wide demand surge, or drops.

The lead-time in “direct-to-store” delivery models gets adversely affected due to various factors. Among them are the mixed orders that suppliers need to fill to optimize transportation on a single store demand; locations of supplier warehouses; and the shipping lead-times.

Inventory

In each of the flow-paths above, inventories are required to be maintained either at the store, or at the warehouse, or at both the places.

In the “direct-to-store” delivery models, the inventories are required only at the stores. However the longer lead-time in this mode of replenishment requires that higher inventories be maintained at the stores for maintaining the desired service level.

In the “warehouse” model, the inventory is required largely at the warehouse with a small safety stock at the store. Low lead-times and guaranteed service levels (along the supply chain arc from warehouse to the store) almost take out the need to maintain sizable safety stock in the stores. This is especially suitable for items with low or intermittent demand as centralized inventory in the warehouse provides optimal inventory deployment scenario.

In the “cross-dock” model, the inventories are likely to be lowest. There are no inventories at the cross-docking facility; and stores need to maintain just enough till the next delivery from the warehouse. The demand planning ordering cycles can be tuned to optimize the inventory requirements.

Supply Chain Processes

Demand Planning

We will define demand planning in this context as demand forecasting, inventory planning, and replenishment planning to produce the final need quantities.

In a “direct-to-store” model, the demand planning process is relatively straightforward. The historical sales at the stores are the clear demand stream that can be directly used for future projections. Also this is a single echelon supply chain model with no requirements for demand propagation, or time-phased planning.

The “warehouse” model primarily targets the replenishment at the warehouses. To calculate the demand at the warehouse, one can use the historical shipments to stores, transfer order requests from stores, or the actual store sales propagated and time-phased at the warehouse echelon of the supply chain. The last one is the most desirable, but also most expensive to model and compute.

The “cross-dock” model can actually combine the best of both worlds for demand planning. It allows the demand to be planned at the store level, but consolidates this demand at the warehouse level so that consolidated orders to the suppliers can be created. This adds some complexity to the process; and may also require that the original store demand be maintained for final disbursement of merchandise at the flow-through center. Alternately dynamic allocations can be carried out at the time of receipt at the cross-docking facility.

Ordering

The process of ordering itself does not change much in the three scenarios. However the number of orders in the system varies widely. As each order incurs a processing cost, the higher number of orders to be processed can become overwhelming.

In a “direct-to-store” model, the purchase orders are created at the store level. This naturally results in a larger number of the purchase orders to be processed. In addition, the ordering constraints like order minimums can further make the process inefficient as the stores have to wait till they have enough demand to reach the order minimum, or artificially inflate the demand that may result into unwanted inventory. The upside though, is that there are no internal transfer orders to plan and execute as the orders are directly delivered at the store.

The “warehouse” model consolidates the store demand at the warehouse. As each warehouse may be fulfilling demand for several stores, it substantially reduces the number of orders to be managed. However there are internal transfer orders to be fulfilled that add to the costs.

The “cross-dock” model also consolidates the individual store demand to create aggregated orders for the suppliers. However this model requires that either the original store demand is retained for distributing the receipts, or an additional process of allocation is deployed to disburse the merchandise at the flow-through center.

Logistics

There are considerable differences in the logistics processes in all the above scenarios.

The “direct-to-store” model can result in a large number of LTL shipments. As orders are created for direct delivery to stores, the opportunity to consolidate orders to create TL shipments gets reduced pushing up the transportation costs. However there are warehouse tasks of receiving, putting-away and fulfillment that get eliminated in this approach.

In the “warehouse” model, the inbound transportation can be greatly optimized through consolidation of orders, and shipments bound for the warehouse. However the warehouse adds its own layer of activities and costs, before the merchandise reaches its final destination at the store. These activities consist of receiving, disposition, put-away, storage, order-wave, picking, packing, staging, and shipping at the warehouse.

The “cross-dock” model provides the same inbound transportation optimization opportunities as above. However it does add some of the warehouse activities and costs. The flow-through requires the merchandise to be received, sometimes broken-up, staged, re-palletized and shipped. However it does save on put-away, storage, order-wave and picking activities at the warehouse.

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