The small parcel shipping problem.
Ordering over the Internet for delivery direct to a customers door is frequently identified as the future of retailing. As product sales move on-line and away from retail stores, the cost of shipping is beginning to dwarf the cost of running a distribution center.
In a recent study I did for an Internet startup company, I was able to get the cost of receiving, storage and picking down to less that a dollar per pick line. But when I added in the cost of packing labor, the carton, and delivery, the total distribution cost increased from under $1.00 per pick to $5.22 for regular UPS shipping, $10.00 for 2nd Day or $21.25 for Next Day Air Saver delivery! (The costs assume zone 8 shipping of a 2 lb. Box containing one pick unit.)
This means, that for this startup company, shipping expenses are between 84% and 96% of the total distribution costs (excluding inbound freight to the DC.) This high shipping cost is one reason why the Internet has yet to emerge as a major force in retailing. Except in a few specific categories, such as books (where 20-50% discounts are given on popular books) and software (that can be downloaded over the Internet) shipping is often too expensive and delivery takes too long. It is often much less expensive to go to the local shopping mall, especially to by an inexpensive item, where shipping expense could come to more than the actual cost of the item purchased.
Why is small parcel shipping so expensive?
When you drive to a local store to make a purchase, the cost of gas and the time to drive and shop just seem like a normal part of your life, and cost of any items you purchase appear to be accurately recorded on the stores receipt. But suppose you charged your shopping time at $10.00/hour for labor and calculated your car expense at $0.32 per mile. Then the cost of a 10-mile round trip to the mall that took an hour, would be $13.20 for shipping expense. Of course, instead of having to wait several days for delivery, your purchase would be available immediately.
Now lets look at what UPS does to earn the $5.22 they charge for the ground shipping charge in the above example:
1. They pick up the package at the vendors warehouse.
2. They transport it about 4000 miles.
3. They provide tracking information so you know where the package is located during shipping and they record when it is delivered.
4. They drive to your house and drop it at the front door.
For the additional expense of next-day or 2nd day shipping, they will fly the package for some or all of the 4000 miles covered. Clearly speed of delivery is an expensive commodity, but the Internet is ABOUT speed.
How to ship both quickly and cheaply.
In Figure 1, we see a sample of a UPS zone map for shipping zones from a specific shipping point (Dallas, Texas.) You can find a similar map for any shipping location on the www.ups.com web site.
Figure 1. UPS ship zones from Dallas Texas for Ground Delivery
Note that the innermost red area is the 1 day delivery zone, and a shipment from Dallas to anywhere in this area will be delivered next-day at Ground shipping rates. The light blue area is the limit of the 2 day delivery zone where shippers get 2nd day delivery at ground rates.
By picking the proper locations for your distribution centers, you could offer low cost 2nd day delivery to over 95% of the population, from only 3 distribution center sites! A network of 10 or 11 distribution centers could give you next-day delivery at ground rates ($3.99 for our test package) to a comparable percentage of the population. Next-day delivery at an EIGHTY-ONE% COST SAVINGS! ($21.25 - $3.99 = $17.26 saved)
By applying these savings to a full range of products, enormous economic and marketing advantages could be achieved by all participating E-tailers. With shipping costs at only $5.00 per package, E-tailers might opt to offer free next-day delivery. This would make buying from a catalog or the Internet not only quick and easy, but also less expensive, especially when the true costs of mall shopping are included.
This is not a totally new concept. The following are just two of many firms providing Next-day for free or Next-day for ground rate service:
1. Digi-Key Electronics in Thief River Falls, MN offers to ship any order over $25.00 in by 6:00PM CT next-day delivery for free and has for several years. (Although it used to be in by 4:00PM.)
2. The Ingram Book Group has 7 regional book DCs that can supply most major population areas with next-day for ground and most of the remainder of the US with 2nd day for ground rates. Ingram is the major wholesale provider of books to most retail book stores including Amazon.com and the Barnes&Nobel and Borders book chains. Ingram stocks about 450,000 titles and ships 175,000,000 books and tapes a year. (About 100,000 a day out of each of their regional locations!)
Figure 2. Ingrams regional distribution network
If its such a great idea, why doesnt everyone ship JIT?
There are three basic reasons why JIT shipping has not been widely tried before now:
1. Most large companies have primarily sold through retail stores. The Internet is changing everything especially now that large retailers and manufactures can, or perhaps we should say, must sell directly to consumers over the Internet in order to maximize margins and profits.
2. Most mail-order merchants have been too small to require 10 regional distribution centers. The cost of running the centers would greatly exceed the savings achieved at all put the largest companies sales volumes.
3. Using previous methods, having multiple distribution facilities has meant large inventories at each location. Many companies have made major inventory cost reductions by condensing into just 1 or 2 distribution locations.
As direct to customer shipments increase in volume due to the Internet, the successful retailers will be those that provide the best service. The Internet is all about Quick, Cheap, and Perfect. Once it is shown to be POSSIBLE to offer free Next-Day delivery, then it will quickly be REQUIRED.
In the following sections, we will address the potential problems that need to be overcome and provide a model that should greatly reduce picking & shipping costs in almost any small shipment order fulfillment system.
Problem #1 Running 10 regional distribution centers is too expensive.
Yes, there are many relatively fixed costs in running a DC. Ten centers require 10 management groups, 10 sets of equipment, 10 operating systems, etc. BUT, suppose the 10 facilities were not owned and operated by one retailer. Suppose a 3rd party logistics provider ran a NETWORK of ten centers. Then each center could ship product for dozens of large and small catalog and Internet retailers.
Instead of one retailer supporting ten centers, view it as ten centers supporting 50 retailers. Then each retailer only pays for 1/5 of the fixed costs of one center! (10 centers/50 companies = 1/5 of a center each)
Further, the network of centers can afford the very best software and hardware solutions, since the costs are spread over many customers. Even the smallest retailers can take advantage of the latest cost and time saving techniques, such as supply chain software, and Internet orders sent directly to the DC floor for picking.
Problem #2 Ten DCs will require too much inventory at each center.
Another or the reasons many companies have consolidated regional DCs is that it takes more total inventory safety stock, to service 10 regional DCs than if you ship from one central location.
To understand why this is true, think of a product with a total national demand of 1000 units per week. If you shipped this from one DC, a safety stock for 1000 additional units (plus the 1000 units we expect to sell) would allow us to ship twice the average demand without running out of stock.
On the other hand, if we shipped from 10 regional DCs, we would divide the inventory into 10 smaller amounts of 200 units in each location. If a peak demand of 300 units occurs in one region, then that region would be short 100 units. If the same 300-unit demand occurred with the single national DC, it would easily be handled for the 1000 unit safety stock held at the single location.
There are two ways to deal with the problem of uneven regional demand:
1. Provide more safety-stock in each regional warehouse. If we held 300 units in each regional DC, that would require 1000 more units in the total system. If each unit cost $10.00, our inventory value would increase by $10,000 and the cost of holding inventory would increase by about $2000 annually or $40 weekly. This extra cost would be repaid by eliminating only 2-3 next-day shipments, out of the 1000 units to be shipped each week!
2. A second way, that would not increase inventory, would be to ship any out-of-stock next-day or 2nd Day shipments by express shipping from the nearest regional DC with surplus stock, if one DC is unable to meet the peak requirement. In this case, you still pay SOME premium shipping charges, but only in exception demand situations, not for EVERY rush shipment, EVERY day!
Problem #3 Ten DCs will require too much inbound receiving and put-away expense.
When you have only one national DC, products are usually received in large quantities and stored in pallet racks until they are needed. As items are picked, more products must be dropped from reserve locations in the warehouse storage area and replenished to the picking area. This receive-store-replenish-pick cycle is a repeated expense, and, if replenishment is too slow, out-of-stocks may occur even when product is in the building.
With 10 regional DCs, each center has only 1/10th of the total stock. It is a relatively simple task to put-away all received product directly into the pick slot. Further, by using advanced software and radio frequency (RF) barcode terminals to identify, receive and place into inventory all products in one step, directly into the pick slot. This smooth flow of product from the manufacturer on an as-needed basis is called Just-In-Time Shipping or Flow Shipping.
Problem #4 The expense, inaccuracy and cost of ordering, shipping and reallocating inventory in a 10 DC JIT network of warehouses.
Along with JIT Shipping, the recent availability of modern Supply Chain Management software allows this network solution as cartons and orders flow smoothly from manufacturers and distributors to regional DCs and final customers.
The principal functions supplied by this software are as follows:
1. Constant monitoring and forecasting of sales demand of each item at each regional DC. Whenever an unexpected increase or decrease in demand occurs, the system will automatically increase, decrease or speed up delivery on the inbound JIT shipment to each center.
2. When stock is forecasted to be critically low, the software will order an express shipment from an alternate regional DC, or it may order express shipments of replenishment stock from other manufacturers or suppliers.
3. All supply chain transactions are immediate and paperless insuring no lost ordering/shipping times and allowing perfect accuracy and availability of information. Normally the only manual interaction required, is the verification count as product is packed out directly on the picking shelves. RF terminals are used to compare the bar coded receipts to the amount ordered, and then to approve immediate payment for the goods received.
Conclusions: Redefining order fulfillment in the Internet Age.
Third Party Logistics providers have been a major force in reducing distribution costs for large numbers of major manufacturing companies. By providing skilled distribution services, they have allowed these companies to concentrate on their core skills -- manufacturing and marketing of products.
I believe the time has come to provide the same level of exceptional service, high accuracy and low cost to a wide range of small and mid-market Internet and catalog retailers and distributors. By combining the best-of-breed JIT shipping techniques and software, tremendous increases in home delivery productivity can be easily achieved. While bricks and mortar retailing will always exist in some fields, perhaps the time has come to reduce the suburban mall sprawl and endless retail chain expansion in favor of shop-at-home Etailing.
Ask yourself, would YOU rather spend your weekends driving and shopping or would you rather point and click and relax while you Leave the shipping to us!