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The Retail Supply Chain

THE STORY OF THE INFORMATION SUPPLY CHAIN

Copyright 2011 Self-published by Steve Keifer All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, scanning, or otherwise, except as permitted under Section 107 or 108 of the 1976 United States Copyright Act, without either the prior written permission of the Publisher. Limit of Liability/Disclaimer of Warranty: While author has used his best efforts in preparing this book, they make no representations or warranties with respect to the accuracy or completeness of the contents of this book and specifically disclaim any implied warranties of merchantability or fitness for a particular purpose. The views, opinions, positions and assertions contained in this book are solely the private ones of the author. Nothing herein is to be construed as reflecting in any way the views, opinions, positions or strategies of GXS, any of its affiliates or any employee thereof.

HERDING GEESE

Chapter 24

CPFR and the Retail Supply Chain

Each summer my family and I spend a week vacationing at the beach. With two young children, the family-oriented town of Ocean City, New Jersey has become our preferred destination in recent years. Vacationing at the beach is increasingly popular with Americans living on the East Coast of the United States. While historically vacationers would stay at beachfront hotels, more and more people are renting a house from a private owner instead. In regions such as the Outer Banks of North Carolina, the Jersey Shore, or the Delaware beaches, renting a house is really the only option. Beach rentals typically extend from Saturday to Saturday. Checkout is late morning Saturday, often at 10AM. Check-in typically follows just a few hours later at 2PM. As a result there is usually a major traffic jam between the hours of Noon and 3PM on major routes leading to beachfront destinations. Not only are the streets full of cars, but the stores quickly fill up with shoppers too. One of the many advantages of renting a beach house is the ability to cook your own meals. Unlike hotel rooms, rental houses come equipped with full-size kitchens and outside grills. While beach house owners will typically stock kitchens with utensils, pots, pans, and tableware, they do not provide any food. Renters must come with all of the ingredients necessary to cook a mealfrom butter and milk to chicken and steak. Some renters purchase before the trip, transporting all the groceries along with them. However, even the biggest SUVs can fill up with beach chairs, suitcases,
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bicycles, and other recreational equipment. Space constraints lead many families to defer food purchases until they arrive at the shore. As a result, there is a massive influx of shoppers to the local grocery stores on Saturday afternoons after check-ins. By 5PM these stores are ransacked. All the key staples such as bread, milk, and butter are depleted from the shelves. The produce selection is sparse with all the best fruits and vegetables picked over. The soft drink and snack aisles are often in significant disarray. Not only are there large gaping holes in the shelves where merchandise is supposed to be, but product is usually scattered throughout the aisles as well. The same situation recurs week after week throughout the summer months. I do my best to avoid the grocery store on the Saturday of beach trips. But sometimes gridlocked parking lots and long checkout lines at the grocery store are a welcome relief from a house full of screaming children. What frustrates me every year is that the grocery stores are consistently out of stock in popular, fast moving items. As a result, I frequently have to make a second stop at a convenience store or return to the grocery store on Sunday. The operators of these grocery stores know that demand surges every Saturday afternoon. Why then are they not better prepared to meet consumer demand for popular products? Certainly the store managers should be able to forecast which products will sell out and to order a surplus of inventory for Saturday afternoons. To be fair the challenge of depleted items is far more complex than one might anticipate, even when there is a regularly established pattern of consumer demand. For almost two decades now, the top supply chain issue in the grocery sector has been out-of-stocks. In 1996, Andersen Consulting and the Coca-Cola Retailing Council conducted a study that found the average out 1 of stock rate in a grocery store was 8.2%. That means if you went to a grocery store seeking to purchase 13 items, chances are you would not find one of them. Numerous studies have been conducted since 1996 by groups such as the Food Marketing Institute (FMI) and Grocery Manufacturers of America (GMA). Surprisingly, most of these studies, although conducted at
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different times and by different groups, all found the average out of stock rate to be 8%. The situation is even worse for "fast moving" items such as salty snacks, dairy products, and carbonated beverages, which average 13 to 15% out-of-stocks.
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Out-of-Stocks
What happens when a product is out of stock? Consumers reactions to out-of-stocks vary depending on the type of products and their individual purchasing preferences. When encountering an out-of-stock, some consumers will simply choose a different SKU. The FMI/GMA study found 3 that substitution of a different SKU occurs in nearly half the cases. Certain categories of merchandise are more susceptible to this type of substitution. For example, consumers are likely to substitute one brand of toilet tissue for another and they may be willing to switch deodorant or soft drink brands. When consumers choose a different SKU, the retailer still gains a sale, but the manufacturer may lose out. In some cases, the consumer may choose a different SKU produced by the same manufacturer. For example, a 12 pack of 12 oz Diet Coke cans was out of stock so the consumer chose to purchase two 6 packs of 16 oz Diet Coke bottles instead. In this case, the consumer remained loyal to the brand so Coca-Cola and its local bottler still gained a sale. However, in other cases, the consumer may choose an alternate brand. For example, the 8 pack of AAA Duracell batteries was out of stock so the consumer chose to purchase an 8 pack of AAA Energizer batteries instead. In this case, P&G, which owns Duracell, lost a sale to its competitor, Energizer Holdings. Not all consumers will accept a substitution. Approximately one third of consumers will visit another store to purchase the product of their 4 choice. For example, if a consumer does not find the 5.6 ounce tube of Aquafresh Extreme Clean toothpaste on the shelf during a weekly grocery trip to Kroger, then he or she may choose not to buy any toothpaste at the grocery store. Instead the consumer makes a separate trip to a drug store, like CVS, to buy the specific Aquafresh SKU he is seeking. In this case, GlaxoSmithKline, which manufactures Aquafresh, retained the sale because
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the consumers brand loyalty was strong. However, the retailer, Kroger, lost a sales opportunity because it was out of stock of this particular Aquafresh SKU. There may be longer term impacts to the consumers relationship with Kroger. The consumer may now be conditioned to expect that Krogers selection of health and beauty items is not equivalent to drug stores such as CVS. As a result, the consumer may change weekly shopping patterns to stock up on health and beauty products at CVS and avoid the associated aisle during Kroger visits. The worst case scenario for both the retailer and the supplier is when the consumer chooses to buy nothing at all. Studies have found that in one fourth of all out-of-stocks consumers do not switch brands or stores. 5 Instead, they will either delay their purchase or not purchase the item at all.

The Problem is Getting Worse

Both grocery retailers and consumer products suppliers have invested significant time and attention to the issue of product availability. There have been investments in new inventory systems to track quantities of each item in the store, on order, and in transit. New technologies such as Radio Frequency Identification (RFID) have been introduced. However, despite the significant investment in research to understand the problem and technology to address the root causes, little progress has been made. Total system wide inventories have remained relatively flat, at 73.2 days, for the last seven years. Out-of-stocks persist at a rate of 8%, remaining largely unchanged over the past five years. Why havent the technology investments achieved better results? There are multiple challenges which have combined to prevent better product availability. To understand the challenges, we need to better understand the root causes of out of stocks and some of the programs implemented to prevent them.
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Lost in the Store

Research studies have identified almost 100 different root causes for out-of-stocks. In some cases, the retail store may have placed a
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replenishment order from its local warehouse, but the goods did not arrive in time to avoid an out-of-stock. Suppliers make order fulfillment errors as well. For example, a retailer may have requested 20 pallets of a particular SKU, but the supplier only ships 15. There is usually sufficient inventory in the supply chain to meet demand. The challenge is that the inventory is not in the right place at the right time. In fact, the inventory is sometimes less than 100 feet from the 7 shelf where the out-of-stock is occurring. Industry studies have found that in one out of four cases when product is out of stock on the shelf, there is additional inventory in the back room of the store. Most suburban grocery stores devote a percentage of the floor space in their stores to store excess inventory. The idea of this on-site inventory storage is to enable products to be replenished quickly without having to call the nearest warehouse for delivery. As consumers, we do not have access to this part of the store. But if we did, we might be disappointed to find out how disorganized the inventory is within back rooms. The poor organization of the back rooms makes it challenging for employees to locate additional inventory. Ironically, studies have demonstrated that stores without backrooms actually experience lower out of stocks. Many stores located in urban areas, in which floor space is at a premium, typically devote as much real estate as possible to merchandise. For these smaller urban shops, products are delivered more regularly then transported immediately from the truck to the 9 shelf. There are also situations in which too much inventory exists for a particular SKU. These overstocks also create challenges for retailers and manufacturers. In the case of meat, dairy products, and fruits and vegetables which are perishable, overstocks will need to be destroyed resulting in a loss. For non-perishables, excess stock may remain in inventory for long periods of time until it is withdrawn from the store. The excess inventory is then sold at a significant discount, which usually results in a loss for either the manufacturer or the retailer holding the goods.
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The New Era of Collaboration

Historically, the greatest challenge for retailers and manufacturers faced with forecasting future sales was that the two do not work together. Both the retailer and the manufacturer each developed their own sales forecasts. As a result, the forecasts frequently were not aligned. The retailer may under-forecast demand leading to an out-of-stock. The supplier may over-forecast demand leading to an inventory surplus. The key variables that affects forecast accuracy are activities that create deviations from historical demand patterns. For example, a retailer may be planning to open a dedicated section of its store for organic food items. The resultant surge in inventory build-up and follow-on sales could drive a 15% increase in order quantities. If the suppliers of these organic products are not aware of the retailers expansion plans, then a supply shortage might arise. Conversely, a consumer products manufacturer may be planning to introduce a new pet food that will cannibalize sales of several of its existing brands. If the retailer is not aware of the new product introduction, then it may build up too much inventory of the old dog food, leading to an overstock. Approximately twenty years ago the retail industry embarked on a series of initiatives designed to reduce out-of-stocks. The foundation of these programs was the need for better collaboration between retailers and manufacturers. The first initiative started in mid-1992 when a group of retailers and manufacturers started the Efficient Consumer Response (ECR) initiative. A third party consultant was engaged to study the potential benefits of operating the grocery supply chain in a more efficient manner. The study found that $30 billion, which at the time was 10% of total industry costs, could be eliminated through the adoption of best practices 10 and new technology. As the grocery industry operates on razor-thin margins, the ECR vision was extremely attractive to most companies. In the following years, several hundred participants from retailers and manufacturers studied new approaches such as computer assisted ordering, continuous replenishment, and Electronic Data Interchange (EDI). The outcome was a series of industry wide recommendations that were
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viewed as the best practices for supply chain efficiency. The ECR movement quickly spread to Europe, Australia, Asia Pacific, and South America where active groups are still executing on these ideas today. One of the focus areas of ECR was a more efficient approach to merchandise assortment in stores. Retailers needed better models for deciding how many items should be carried in a store for a particular category. Methodologies were also required to determine what mix of sizes, flavors, and packages should be carried and how much space should be allotted for each item. A new concept called category management was introduced. Category management encouraged retailers to think about each aisle in the store as a stand-alone business with a specific growth strategy. Examples of merchandise categories might include international foods, baked goods, or health and beauty items. The revolutionary concept that underpinned category management was the close collaboration between the retailer and the supplier. With category management, retailers sought to leverage the expertise of the suppliers in the merchandising strategy. Retailers would typically appoint one supplier as the category captain, providing them with access to privileged retailer data and empowering them with a high degree of influence over the sales and marketing strategy. The theory was that the supplier should know the consumer demographics, pricing strategies, promotional tactics, and demand patterns for its products better than anyone. In addition to delegating merchandising and marketing strategy to suppliers, some retailers also empowered suppliers to manage the inventories in their stores. One of the more effective programs introduced in the 1990s by retailers including Walmart and Home Depot is called Vendor Managed Inventory (VMI). With VMI the suppliers assumed responsibility for organizing the displays and stocking the shelves in the retailers stores. They also held the responsibility for forecasting sales. The suppliers benefited by having greater control over the appearance and placement of their products in the stores. If executed properly, it was believed that VMI would lead to fewer out-of-stocks and less excess inventory in the supply chain.
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Since the introduction of VMI there have been numerous permutations introduced to the market. One of the more interesting variations is called Scan Based Trading. With Scan Based Trading, the supplier not only manages the inventory in the store, but it also owns the product until it is scanned at the checkout aisle. The supplier decides the assortment of merchandise to be displayed on the shelf, stocks the store with inventory, and collects payment for goods sold. If the goods do not sell, then the supplier reclaims the inventory from the store, which will then be destroyed, recycled, or liquidated on a secondary market. Scan Based Trading became popular between the years 1999 and 2004. A GMA study in 2000 found that Scan Based Trading could lead to 3 to 4% uplift in sales due to higher product availability levels. The study also found that pricing errors were reduced by 70% and invoice disputes were effectively eliminated. Although Scan Based Trading has been experimented with by a number of retailers, only a handful of suppliers in merchandise categories such as greeting cards, magazines, and newspapers, use the approach today.
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See Far with CPFR

In 1995, another collaboration initiative between retailers and manufacturers was introduced by Walmart. The program was called Collaborative Forecasting and Replenishment or CFAR (See-Far). In 1996, Walmart conducted a pilot program with its supplier Warner-Lambert to prove that product availability for Listerine products could be improved 12 through better collaboration. The results of the pilot were presented to the Voluntary Interindustry Commerce Standards Committee (VICS), which assumed ownership of the initiative. Shortly thereafter, the name was changed to Collaborative Planning, Forecasting, and Replenishment (CPFR) to emphasize the need for longer term engagement. The first CPFR model was published in 1998. It consisted of a ninestep program that retailers and manufacturers could follow to align forecasts and orders for particular SKUs. Several iterations of the model were introduced in the following decade. CPFR starts with a business plan being
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developed between a retailer and a manufacturer. The two parties agree on merchandising strategies and sales targets. Next, the retailer and the manufacturer work to jointly develop a sales forecast. Numerous factors including historical sales, lead times, and inventory positions are considered for the forecast. Information about upcoming events that might significantly impact supply and demand is exchanged. For example, retailers might share plans for new store openings or changes to inventory policies. Manufacturers might share plans for new product introductions and price promotions. There was a tremendous amount of hype surrounding CPFR following its introduction in the late 1990s. CPFR was widely viewed as a panacea for all the retail industrys problems. Early case studies demonstrated that companies could reduce inventory levels while increasing sales through CPFR. A number of large retailers including Walmart, Best Buy, Dillard's, Lowe's, CVS, Sears, and West Marine embraced CPFR as a business strategy. Leading suppliers such as P&G, Liz Claiborne, Scott's Miracle Gro, Kimberly Clark, and Hewlett Packard also championed CPFR. There were plans to export CPFR to the automotive and high tech industries as well as numerous countries around the world. CPFR became the new thing in the B2B e-commerce industry. Supply chain thought leaders began touting CPFR as the holy grail of demand planning. Similarly the B2B e-marketplaces discussed in earlier chapters, a bubble quickly emerged in CPFR technology investment. There were venture capital-backed startups such as Syncra that exclusively focused on CPFR. All of the big ERP and supply chain planning vendors from SAP and JDA Software to i2 Technologies and Manugistics Group introduced CPFR applications. Systems integrators such as IBM, Accenture, Capgemini, and Deloitte introduced CPFR practices. The industry analyst community fueled the fire as AMR Research and Gartner began to publish reports extolling the benefits of CPFR. A level of hype quickly emerged as well as a set of unrealistic expectations that no technology could possibly fulfill.

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As a result, formal adoption of CPFR lagged behind expectations. Many companies viewed the formal nine-step process of CPFR as too complex. Others were overwhelmed with the level of business process reengineering that would be required for success. In the end, many companies opted to embrace individual tenets of CPFR rather than religiously adhering to the full business process. Perhaps the greatest challenges with CPFR related to retailers willingness to share data with suppliers. A number of cultural and political issues exist in the retail supply chain which will be the focus of the next chapter.

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References

1.

Michael Garry, New Coke study offers tech solutions, Progressive Grocer, April 1, 1996 2. Thomas W. Gruen, Ph.D., Dr. Daniel S. Corsten, Sundar Bharadwaj, Ph.D., Retail Out of Stocks: Worldwide Examination of Extent, Causes and Consumer Responses, Food Marketing Institute, Grocery Manufacturers Association and CEIs - Food Business Forum, 2002 3. Thowas W. Gruen, Ph.D and Dr. Daniel Corsten, A Comprehensive Guide to Retail Out-of-Stock Reduction in the Fast-Moving Consumer Goods Industry, Grocery Manufacturers Association; Food Marketing Institute; National Association of Chain Drug Stores, 2007 4. Ibid 5. Ibid 6. New Ways of Working Together, Voluntary Interindustry Commerce Solutions, Market Techniques & Innovations Inc., and Corporate Executive Board, 2008 7. Thowas W. Gruen, Ph.D and Dr. Daniel Corsten, A Comprehensive Guide to Retail Out-of-Stock Reduction in the Fast-Moving Consumer Goods Industry, Grocery Manufacturers Association; Food Marketing Institute; National Association of Chain Drug Stores, 2007 8. Ibid 9. Ibid 10. Backgrounder: Efficient Consumer Response, Food Marketing Institute, http://www.fmi.org/media/bg/?fuseaction=ecr1 11. Scan Based Trading - Enabling E-Commerce Through an Intermediary Service Provider Direct Store Delivery Pilot Study, Grocery Manufacturers Association and Food Marketing Institute, 2000 12. John W. Verity, Clearing the Cobwebs from the Stockroom, Business Week, June 14, 1997, http://www.businessweek.com/1996/43/b3498166.htm

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