Outside The Box Distribution - Three Dimensions for Distribution Excellence
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The document discusses the significance of innovative distribution strategies for manufacturers to enhance profitability and adaptability. Companies that excel in distribution can achieve a 15 to 30 percent cost advantage, significantly improving service levels and competitive positioning. It emphasizes the need for firms to benchmark against suitable peers beyond their industry, adopt appropriate technology, and potentially consider outsourcing to optimize their distribution operations.
Outside The Box Distribution - Three Dimensions for Distribution Excellence
- 1. “Outside the Box” Distribution How to deliver best-in-class distribution performance
- 3. P roduct distribution is critical to top-line growth and bottom-line performance for manufacturers and their channel partners across virtually all industries. An efficient and competitive distribution operation can increase profits, while an inefficient operation can inflate costs and depress top line potential. Companies that achieve best-in- class distribution are more flexible, can realize a 15 to 30 percent cost advantage over average peers, provide customers with better quality and lead times, and are more able to adapt to change. When Toys "R" Us entered the online retail petitor Lowe’s. Since Home Depot migrated business in the late 1990s, it lacked the requisite its DSD network in favor of in-house distribu- distribution capabilities and experience to support tion, the results have been positive — plus the the new channel. The company tried various company has leap-frogged the conventional distribution operating models, beginning with stock-and-pick distribution model to go with a in-house distribution, then migrated to an out- flow-based model. sourced relationship with Amazon, and finally How did these companies finally succeed parted ways with Amazon in 2006 to partner after years of distribution setbacks? Both compa- with Exel, a third-party logistics provider. Today, nies learned to think outside the box and thus comfortably delivering products via its online improve their distribution performance. channel, the toy company still bemoans “the lost years” when it was unable to achieve its top line Thinking in Three Dimensions e-commerce market penetration goals. What allows certain companies to deliver best-in- Home Depot also had its share of distrib- class distribution performance while others deliver ution headaches. The do-it-yourself behemoth average performance or fail altogether? From our spent 20 years opening new stores and establish- work in this area, the leaders in distribution — ing regional store clusters supported by a direct- those that deliver on a defined set of quality and to-store delivery (DSD) model. Never getting service levels at the best possible cost — consis- a total store net-work perspective, by the mid- tently think “outside the box.” They push their 2000s its fragmented supply chain was harming competitiveness to an efficiency frontier, achieving profits and causing customers to shop at com- a 15 to 30 percent distribution cost advantage “OUTSIDE THE BOX” DISTRIBUTION | A.T. Kearney 1
- 4. over competitors while delivering equal or better of complacency. The leaders understand their true levels of service. Some of these leaders go a step peer group and compare their distribution perfor- further to improve performance across the entire mance against these peers. value chain—from demand planning, to inven- Determining which companies are your true tory and logistics—both to improve the top-line peers can be somewhat difficult, however. It is not and unlock additional savings. For example, unusual to find after years of benchmarking that restructuring delivery programs can reduce inven- you’ve been comparing performance against the tory carrying and freight costs. wrong peer group. For example, a firm in the We call this “3D” outside-the-box thinking motor-vehicle sector historically benchmarked its because it requires the following three dimensions: after-market distribution against the automotive industry and ranked its cost-to-serve in the top 1. Benchmark Beyond Industry Boundaries 90th percentile. This is illustrated in the top Solid distribution requires first establishing an panel of figure 1. Was this motor-vehicle firm accurate picture of your distribution competitive- really performing in the 90th percentile? We ness vis-à-vis true peers. The leaders establish didn’t think so. This company, like many others, a competitive gap assessment whereby they was mistakenly defining its peer group largely neither underestimate their distribution capa- by its overall business profile rather than by bilities (devoting valuable resources without an its after-market business requirements. When adequate return on investment) nor overestimate benchmarked against firms in other industries their performance and get lulled into a false sense with similar distribution requirements — mid- Figure 1 Benchmarking against the right peer group is essential to informed decision making Approach Cost benchmarking ($/grab unit) Result • Select peers within • Assume in-house operations the industry sector are competitive Before • Compare performance • Obtain a false sense of against leading auto security and industrial vehicle manufacturers Client Leading peers Approach Cost benchmarking ($/grab unit) Result • Select peers with similar • Identify significant cost distribution profile and gaps and improvement characteristics regardless potential After of industry • Reevaluate the rationale and • Compare performance limitations of an in-house against mid-tier apparel distribution model retailers and after-market parts providers Client Leading peers Source: A.T. Kearney analysis 2 “OUTSIDE THE BOX” DISTRIBUTION | A.T. Kearney
- 5. scale apparel retailers and after-market parts 2. Challenge Preconceived Views firms — the company discovered its distribu- Determining what is the right level of technology, tion performance was lagging well behind others. or whether or not it makes sense to outsource or The results are shown in the bottom panel of insource (make versus buy) are key decisions that figure 1. Rather than rely on proxies for selecting a peer group for bench- marking such as “what industry do Distribution leaders push I play in?” or “who are my direct competitors?,” distribution leaders their competitiveness to an use segmentation metrics to identify the correct benchmark peer group. efficiency frontier — achiev- Figure 2 illustrates some possible dimensions and metrics to look for ing a 15 to 30 percent cost in peer selection: scale, order han- dling, product and service profiles, advantage over competitors. and even the geographic region the customer base is in. The segmenta- tion variables should have sufficient detail to: affect distribution. The right solution in fact has capture the key operational dimensions that both components: technology and a make-versus- characterize the underlying distribution require- buy assessment. Let’s discuss each: ments, and align with the company’s overall Selecting fit for purpose technology. Dis- business strategy as well as customers’ needs. tribution technology includes a holistic suite of Figure 2 Dimensions and metrics to consider in peer selection Dimension Associated metrics Rationale Scale • Number of outbound order lines per year* • Creates baseline for total outbound labor handling requirements Order handling • Distribution of outbound orders across picking/packing • Determines labor requirement for picking, handling categories, namely: full case picking, break pack packing and shipping orders unit picking, break pack pre-packed picking Product profile • Number of unique stock-keeping units (SKUs) • Gauges how product size and dimensions affect • SKU distribution across the high-, medium- and low- productivity and labor requirements across all velocity profile activities • Physical dimension of SKUs Service level • Percentage of outbound orders across lead time cutoffs • Assesses how service level affects order lead (for example, next-day air or three-day guarantee) time requirements Customer • Number of customers segmented by geographic regions • Considers freight mode versus lead time tradeoffs geography Note: *An order line is an SKU-based line on the order receipt Source: A.T. Kearney analysis “OUTSIDE THE BOX” DISTRIBUTION | A.T. Kearney 3
- 6. Figure 3 Issues to consider when determining appropriate level of distribution technology Technology level Low Medium High Pick zone Manual carts • Partial conveyer system (in high velocity • Full conveyer system routing and picking zones) • Automated robotic systems passing • Pallet runners and forklifts Paper picking • Smart carts (mobile radio frequency (RF) • Fixed pick-to-light zones Piece or pick-to-light on carts) • Fixed laser pick zones or unit • Voice-based pick zones • RF pick zones (wireless bluetooth) picking Distribution • Automated robotic systems technology categories Manual order • Automated storage and retrieval systems • Automated conveyer sorting Packing consolidation (AS/RS) and carousel tote systems and zone diverts and and verification • Manual conveyer sorts • Automated weight checking shipping • Automated weight checking Spreadsheet • Order batching and stock • Enterprise WMS WMS* based; limited keeping unit (SKU) slotting • EDI and XML data integration and IT integration • Enterprise WMS • RFID tracking • EDI and XML data integration • ERP integration Notes: *WMS is warehouse management systems; EDI is electronic data interchange; XML is extensible markup language; Source: A.T. Kearney analysis RFID is radio frequency identification; ERP is enterprise resource planning warehouse automation, material handling systems smarter: The company plays in an industry with and warehouse management system (WMS) soft- well-defined customer segments characterized by ware that collectively enable distribution, from large-scale orders and a significant amount of com- product receiving to shipping (see figure 3). plexity. There are multiple stock-keeping units Determining the appropriate level of distribution (SKUs) per order and few opportunities to consol- technology, or whether or not you need it at all, idate orders. Therefore, an automated process requires considering several trade-offs, including would offer a better cost-value tradeoff. capital investments, productivity, and longer term What is the lesson from this example? There flexibility. To illustrate, executives of an industrial is a long list of issues to consider when making machinery company asked whether they needed a distribution technology decision. The technol- an automated system and decided against it. ogy should align with the distribution require- Instead, the firm implemented a largely manual ments as dictated by order profiles of current and distribution center (DC) solution. When pressed future customer segments. The key considerations for an explanation, the main decision makers said are the complexity that a given distribution center it was primarily because of the company’s corpo- must support and the need for flexibility. Figure 4 rate policy of rationalizing capital investments in depicts the key criteria to inform the degree of “non-core” competencies. Their decision, how- flexibility versus the degree of complexity. ever, was not the right one. Note that the optimal configuration may Indeed, there was sufficient evidence to sug- not require a homogeneous solution across the gest an automated solution would have been entire distribution network. Certain network nodes 4 “OUTSIDE THE BOX” DISTRIBUTION | A.T. Kearney
- 7. Figure 4 Mapping distribution center technology to distribution requirements High Distribution complexity and scale • Geographic coverage (regional or national customers served) Low-tech • Number of distribution channels served solution • Number of orders and breakdown of labor-intensive activities Flexibility requirement (break pack and unit picking) • Order fulfillment lead time (average time and variance from order drop to shipment) • Daily orders predictability • Variation in order basket • Inbound suppliers and shipment variation Medium-tech solution Flexibility requirement High-tech • Percentage of volume from stable business compared to solution emerging or risky business • Role for distribution center in context of the long-term business strategy • Material change in channel mix (for example, growth in Low the online channel) Low High Complexity and scale Source: A.T. Kearney analysis (or distribution centers) can have a less automated, tions and improve delivery time. In addition, by less technological setup while others can have a expanding their distribution network, they could more automated high-tech configuration. also lower freight costs as a portion of outbound Performing the make-vs.-buy assessment. orders could switch from air to land parcel (due to Distribution gaps can be closed by tapping into closer proximity to customers). the external market for key capabilities. For Finding the optimal make-versus-buy balance example, third-party logistics providers can help and then executing an outsourcing initiative reduce costs and allow companies to offer differ- requires the following: entiated services. Adopt a strategic view. Before dismissing We can use another example from the motor outsourcing as too risky or embracing it as a silver vehicle industry to illustrate this. This vehicle bullet to achieve best-in-class competitiveness, company handles distribution in-house, and while the risks and the benefits should be systemati- executives have considered using a third-party cally weighed, as shown in Figure 5 on page 6. provider for distribution, strong internal hurdles The three main questions to answer: Is product such as a unionized workforce always prevented it. distribution a core competency? Is there a cost The recent economic downturn provided an oppor- advantage to outsourcing? Is there a third-party tunity to perform a make-versus-buy assessment, provider that could handle the job? Answering and executives jumped at the chance. They found these questions will help develop a good under- that by outsourcing aftermarket distribution, they standing of the cost benefits and risks associated could save more than 20 percent in DC opera- with outsourcing. “OUTSIDE THE BOX” DISTRIBUTION | A.T. Kearney 5
- 8. Figure 5 The framework for making a “make versus buy” decision Strategic Economic Value capture Is product distribution Is there a cost Is there a third-party a core competency? advantage to adopting distribution provider or migrating to an that could handle • Do you rely on product outsourced model? the job? distribution as a key competitive advantage? No Yes Yes Outsource • Is this cost advantage • Do you possess net of switching costs sufficient bargaining • Do you possess the (considering capital power vis-à-vis vendors critical technology outlay and restructuring to capture the cost or proprietary infor- costs)? advantage ? mation processing in distribution? • Is the cost advantage sustainable? Yes No No In-house In-house In-house Source: A.T. Kearney analysis Understand the third-party logistics market the low-cost or the most high-tech provider, the trends and capacity early. Third-party logistics ideal 3PL has a solution and technology that is provider, also called 3PL, capacity must be under- aligned with your distribution requirements. stood at both the industry and individual levels. Consider strategic fit in the due-diligence A provider with limited capacity could drastically process. During 3PL selection and due diligence, temper a firm’s bargaining power during negotia- the intangibles matter — looking at the strategic tions or may even rule out outsourcing as a viable fit of your business through the lens of the 3PL. option. Performing a capacity assessment early There are a few questions to ask: Are my distribu- on—before launching an official supplier bid tion requirements and capabilities a focus area for process and due diligence—can save significant the 3PL? How will my business affect the 3PL’s time and resources and better inform downstream overall revenue base? Is my industry vertical a key bargaining power, which is crucial to capturing sector for the 3PL? Answers to such questions will cost advantages from outsourcing. not only provide a stronger bargaining position Recognize technology differentiation in the but also ensure that the 3PL continues to be 3PL market. Although all large integrated third- responsive and flexible after the contract is signed. party logistics providers possess broad capabilities Given the high switching costs and steep and can arguably play across the entire technology learning curve associated with outsourcing dis- spectrum, many tend to have a technology “sweet tribution operations, doing a rigorous 3PL due spot.” Figure 6 shows the leading 3PLs and their diligence and selecting the right partner is pivotal core technology sweet spots. Rather than go with to success. 6 “OUTSIDE THE BOX” DISTRIBUTION | A.T. Kearney
- 9. 3. Trigger Chain Reaction in Supply Chain Figure 7 on page 8 outlines some of the Optimization implications of inventory carrying costs dis- Early successes in distribution can be a catalyst for covered while redesigning a distribution network. change. Transformational change usually requires It could reveal poor inventory turns and inaccu- first getting past organizational impediments such rate cycle counts as underlying root causes of as silos where key decision makers sit in different supply chain inefficiencies, or inventory prob- functions and departments and there is very little lems could be symptoms of poor compliance collaboration among the groups. Focusing on a of inbound shipment suppliers. Going through particular activity such as distribution can create a a simple exercise can uncover improvement areas “wedge” to break down organizational and func- in the overall supply chain and encourage cross- tional silos and drive broader transformation functional collaboration. across the entire supply chain—from demand A recent client example will help explain this forecasting to inventory and freight management. point. This company consistently grappled with a We have created situations in which the inventory 75 to 100 percent gap in inventory turns com- management group is brought in to discuss the pared to its top competitors. Executives blamed implications of footprint redesign on inventory the poor performance (and inability to fix it) on stocking and carrying costs. This conversation organizational constraints and supply chain com- leads to other questions and uncovers additional plexity. The organizational constraints essentially opportunities in inventory management that can put the logistics group in charge of distribution dwarf the original distribution opportunity. and logistics, while the product group managed Figure 6 Core technology “sweet spot” for leading third-party logistics providers (illustrative) Philosophy on solutions technology Low High Exel Cat Logistics Genco Ceva Uti Source: A.T. Kearney analysis “OUTSIDE THE BOX” DISTRIBUTION | A.T. Kearney 7
- 10. Figure 7 Distribution can be the catalyst for a value chain transformation Starting point Sourcing Category Inventory Distribution Logistics and supplier management management (operations) (operations) management (marketing) (inventory) (procurement) IT and finance • Demand planning • Demand forecasting • Materials sourcing • Distribution center • Import and export Improvement areas • Assortment planning • Order management technology and planning • Product life-cycle • Replenishment 3 • Supplier compliance solution engineering • Shipment reliability planning • Freight and load 2 consolidation • Inventory carrying 1 • Distribution foot- • Shipment tracking and stocking • Supplier base print and network configuration • Replenishment • SKU rationalization Source: A.T. Kearney analysis inventory policies. The reasons for the problems Challenging Entrenched Perspectives were becoming clear. The logistics group could As companies continue to enter new market seg- not improve its distribution operations since they ments, create new channels to markets, and roll were so tightly intertwined with inventory (for out additional products and services, distribution example, the tradeoffs between number of distri- will always be essential to profitable growth. Best- bution centers in a network versus inventory car- in-class performance requires thinking outside the rying costs), and the product group was not that box and challenging entrenched perspectives. interested in improving inventory turns. The steer- Benchmarking across industry boundaries to ing committee used a DC improvement initiative identify true distribution gaps and potential, as a catalyst to improve total operations—expand- conducting rigorous assessments of technology ing the scope of this one initiative to launch a needs and make-versus-buy decisions and closing holistic distribution network restructuring that performance gaps can drive broader transforma- included revamping inventory carrying policies. tions across the entire supply chain. Authors Joachim Ebert is a partner in the operations practice and head of the firm’s complexity management practice. Based in the Chicago office, he can be reached at joachim.ebert@atkearney.com. Kumar Venkataraman is a principal in the firm’s operations practice. Based in the Chicago office, he can be reached at kumar.venkataraman@atkearney.com. Michael Hu is a consultant in the firm’s Chicago office and can be reached at michael.hu@atkearney.com.
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