Decisions and costs.

Your CEO makes an announcement about a change in policy. The statement may sound straightforward, but must Supply Chains be changed to meet the new objective? And does the CEO understand what the Supply Chain professionals will need to do and by when?

These questions were highlighted by the actions of a major discount department store chain in Australia that has fallen on hard times. The parent company appointed a new division manager and one of his statements to the media was that the pricing policy would change from ‘high-low’ to ‘everyday’. What does that mean for Supply Chains?

The pricing policy of ‘high-low’ is also called ‘investment buying’. Gross margin per order is the main measurement and also the basis for bonus payment to retail buyers. They negotiate with suppliers to get the lowest purchase cost, for which the supplier wants high volume, typically delivered as one order. The lower purchase cost can be passed on as lower prices for consumers. But large orders delivered into a retailer’s warehouse(s) generate Logistics costs, which are not charged to orders, so the net profit of each buying contract is not known. Additional costs are:

• Larger warehouse required to store excess inventory
• Short term overflow storage space rental and costs of double handling
• Peaks of overtime work or hiring short term casual employees when large orders arrive
• Cost of holding excessive inventory, including costs of tracking and administering the inventory

Another cost with the high-low pricing approach is in the assumption that a small proportion of the purchase will be discounted in sales promotions. The danger of discount promotions is that consumers delay their purchases until the sale period. Less sales at full price increases the proportion that must be discounted; decreasing profits.

‘Everyday’ pricing assumes that a ‘competitive’ price is charged every day. Promotional events are within the product’s merchandising plan, not just to clear excess inventory. To be successful, ‘everyday’ pricing requires changes in Supply Chains, due to a change in the basis of bonus calculation – from gross margin to net margin.

The role of Logistics will change from managing the storage of items in warehouses to managing a regular flow of items through distribution centres (DCs). This could require a redesign of Logistics facilities located at each of the four largest cities (Brisbane, Sydney, Melbourne and Perth).  Centralised distribution is generally not cost effective in Australia, due to State capitals being widely spaced across the large landmass and the cost of internal transport. There is not an import shipping cost penalty, as freight rates are the same to each port.

As Australia is in the southern hemisphere, it affects the sequencing orders from suppliers in Asia. The retailer’s relatively small demands for seasonal products (such as apparel) are opposite to the demands of large, northern hemisphere retailers. Under ‘high-low pricing, suppliers negotiate for Australian retailers to take delivery (and hold stock) out of season, which adds to the inventory in warehouses.

Under ‘everyday’ pricing, suppliers must manufacture within the selling season. Delivery cannot be interrupted by the capacity demands of northern hemisphere retailers at factories and ports, nor long holiday shutdowns at suppliers i.e. Chinese New Year. This situation could lead to establishing contracts with smaller suppliers in countries other than China. A willingness to make against a customer’s delivery requirements may result in higher buying costs, but a lower total cost of ownership (TCO).

Total Cost of Ownership

Logistics should be required to provide input concerning TCO decisions:

• The number of SKUs. The Chief Executive requires a substantial decrease from the current 60,000. The objective should be that all available items are on view in a store, although that is a challenge with the ‘size, colour, fit’ assortment of apparel
• Location for shipping and inventory finance and insurance – head office or an office in Asia?
• Store Ready Merchandising (SRM) requires that items are price ticketed and scan-packed ready for presentation on the retail shelf; this complies with the assortment plan for each retail shop. No secondary sorting is required at a retail store. The choice will be:
  • SRM at each State based DC or outsourced to a nearby service provider. Suppliers are likely to ship goods direct in FEUs (forty foot equivalent unit) containers, with a minimum storage of 50 cubic metres. If the delivery is less than a FEU, goods are sent to the retailer’s forwarding agent for consolidation, prior to shipment
  • SRM facilities provided (by an LSP?) at a site within a defined radius of the shipment port. Suppliers to operate a Vendor Managed Inventory (VMI) process into the SRM location. Containers are packed according to the assortment plan for each retail shop. Cross docking occurs at DCs in Australia prior to store delivery
• The total door to door time for orders and the acceptance time at links in each Supply Chain. Include the high number of items purchased from importers.
  • An approach under ‘high-low’ pricing is to allow 8 weeks from Asian supplier’s factory gate to a retail shelf and hold 9 weeks of inventory in the warehouse
  • Under ‘everyday’ pricing and a flow approach, Logistics will substantially reduce these figures. For example, the shipping time from a China port to an Australian port can be between 15 and 30 days depending on the shipping company and route

Performance measurement

The Sales & Operation Plan (S&OP) process should be a critical feature of the ‘everyday’ pricing approach, facilitated by Supply Chain/Logistics. As part of the S&OP implementation or renewal, decision are required concerning:

• Whether buyers or Logistics are responsible for forecasting demand and allocating store replenishment. Included in the decision is the amount of reliance on externally generated buying signals and IT based algorithms
• Measuring the suppliers ‘order fulfilment rate’ (delivery in full, on time – DIFOT)
• An IT application to assist in planning the flow of orders, identify slow moving and obsolete (SLOB) product lines and calculate the TCO by order

The initiatives required within the retailer’s Supply Chains are more than those noted in this post. However, these provide an indication that when your CEO makes a statement concerning strategies for the organisation, it is a signal for Supply Chain professionals to ask searching questions about possible effects on the Supply Network.