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Retail Supply Chain Network Design Unplugged

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The proverbial challenge and ultimate goal for retailers, CPG and manufacturing-centric companies alike is getting the right SKU to the right store, with the right quantity, at the right time. What we at enVista find problematic is that most supply chain network designs are focused on where to place a distribution center from a geographical standpoint and how to minimize transportation costs (least cost analysis using multi-integer programs) vs. how to maximize profitability through inventory optimization and improved sales. Maximizing profitability and inventory optimization should be the primary drivers for a strategic network design. So why is this usually not the case?

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From our experience, the answer partially lies in organizational design, and metrics across the organization that are not aligned with balance costs and profit optimization. When consulting firms are engaged, most do not focus on maximizing profit, margin retention and improved comparative store sales. Profitability can be maximized by: margin retention of items (minimize mark downs), elimination of obsolete inventory, and maintaining low cost operations (LCO).

A strategic retail network design should not and cannot be driven by a SVP of Logistics or Transportation in isolation–emphasis on the word “RETAIL NETWORK.” Retail supply chain network designs should be driven first and foremost by those who own the inventory (merchants, buyers, allocators and inventory analysts). This is not to say that your VP of Distribution or Transportation should not be engaged in the process, but the real opportunity is not where to place a distribution center on a map. Rather, it is understanding how to buy, assort, allocate and replenish inventory to meet the needs of your single or omni-channel customers. Tell me how you buy and allocate and I will tell you how your supply chain should operate.

With an eye toward profitability, we would rather enable a retailer to plan and buy the right product and quantity and allocate to the right store (speed to market) protecting margin on a $75 pair of shoes, versus saving $.05/unit on transportation. We are not advocating that retailers overlook cost-saving opportunities; on the contrary, we are a LEAN supply chain consulting firm, focused on eliminating WASTE (Muda). However, a retailer’s largest area of WASTE is Inventory/wrong item, too much and/or allocated in the wrong place.

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So the question becomes how to improve turns based upon supply and demand variability. We just finished a retail network design where we actually increased warehousing and transportation costs ($4.6M annually), but reduced the retailer’s working capital by $27.9M, including reducing carrying costs by $3.34M (12%) each year and improved comp sales by 4.2% ($42M annualized, $1B Retailer). This particular retailer has gross margins of 45%, hence a $18.9M increase in gross profits will occur. We first dynamically simulated the results (vs. static optimization) and then proved it through a 25-store test model. Had we focused only on warehousing and transportation costs and safety stock at their DCs (vn rule), we would have missed the mark. Our focus was driving more sales, while improving total store and distribution inventory turns. And I encourage you to take this same focus within your own supply chain network projects.

The project I just described was a deja vu experience for me. Early in my career as a Process Industrial Engineer working for Johnson and Johnson (JNJ) we were focused on eliminating Work in Process (WIP) and Finished Goods inventory. Unfortunately, inventory is captured as an asset on a company’s balance sheet. At JNJ, we moved from labor cost accounting to Throughput accounting principles (Profit = Sales – Total Cost to Serve (burdened with inventory capital and carrying costs). Supply chain guru and thought leader Eli Goldratt stated, “Metrics drive behavior.”

As supply chain practitioners, are we measuring the right goals? At enVista, our experience has shown that supply chain leaders must be focused on driving profitability with good process design from merchandise planning to store replenishment while “managing” supply chain costs. We believe it is about improving the customer experience by synchronizing: inventory, orders and customers. As a result, supply chain network designs cannot be initiated with a focus on DC placement or transportation costs in isolation.

In summary, when designing a retail supply chain you need 1) C-Level Involvement across the entire enterprise (CMO, CIO, CFO and COO), 2) resources who control and own your inventory, 3) resources who own your retail applications and supply chain execution technology and 4) supply chain practitioners who own the physical distribution of the inventory.

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