Online Sales and the Distribution Network in the Supply Chain

In this section, we use ideas discussed earlier in the chapter to see how the Internet has affected the structure and performance of various distribution networks. The goal is to understand what drove the successful introduction of online sales in some networks and not others, and how these networks are likely to evolve.

Similar to our consideration with distribution networks, we build a scorecard based on how online sales affect a supply chain’s ability to meet customer needs and the cost of meeting those needs. We now detail the contents of each scorecard category.

1. Impact of Online Sales on Customer Service

As with distribution networks considered earlier, we start by studying how online sales affect customer service elements such as response time, product variety, availability, customer experi­ence, time to market, visibility, and returnability. We also look at factors such as direct sales and the ability to offer flexible pricing that help companies selling online.

RESPONSE TIME TO CUSTOMERS When selling physical products that cannot be downloaded, customer requests take longer to fulfill through online sales than in a retail store because of the shipping time involved. Thus, customers who require a short response time may not use the Internet to order a product. There is no such delay, however, for information goods. The Internet has facilitated almost instantaneous access to movies, music, and books in digital form.

PRODUCT VARIETY A company selling online finds it easier to offer a larger selection of prod­ucts than a bricks-and-mortar store. For example, Walmart.com offers a much larger selection of products than Walmart stores do. Offering the same selection at a store would require a huge location with a correspondingly large amount of inventory.

PRODUCT AVAILABILITY By aggregating its inventory, a company selling online improves product availability. Better information on customer preferences also allows firms selling online to improve availability.

CUSTOMER EXPERIENCE Online sales affect customer experience in terms of access, custom­ization, and convenience. Unlike most retail stores that are open only during business hours, the Internet allows a customer to place an order at any convenient time. In fact, W.W. Grainger has observed a surge in online orders after its bricks-and-mortar stores close. Online sales also allow a firm to access customers who are geographically distant. Using the Internet, a small specialty retail store located near Chicago can reach customers all over the United States—or even the world. Access to online sales is limited only by the customers’ access to the Internet.

The Internet offers an opportunity to create a personalized buying experience for each cus­tomer. For example, Amazon displays products that are related to what customers have recently purchased or browsed. Firms that focus on mass customization can use the Internet to help cus­tomers select a product that suits their needs. For example, Pella allows customers to design their windows on the Pella website.

For both consumers and companies, online sales can increase the ease with which one does business. Customers do not have to leave home or work to make a purchase. For many compa­nies selling online, such as Peapod, information from past purchases is used to significantly speed up order placement for the customer.

FASTER TIME TO MARKET A firm can introduce a new product much more quickly online as compared with doing so via physical channels. A firm that sells electronics through physical channels must produce enough units to stock the shelves at its distributors and retailers before it starts to see revenue from the new product. A firm selling online, in contrast, makes a new prod­uct available online as soon as the first unit is ready to be produced. This is evident at Walmart. com, where larger new TVs go on sale well before they are sold at Walmart stores.

ORDER VISIBILITY The Internet makes it possible to provide visibility of order status. From a customer’s perspective, it is crucial to provide this visibility because an online order has no physical equivalent to a customer shopping for an item at a retail store.

RETURNABILITY Returnability is harder with online orders, which typically arrive from a cen­tralized location. It is much easier to return a product purchased at a retail store. The proportion of returns is also likely to be much higher for online orders because customers are unable to touch and feel the product before their purchase. Going online thus increases the cost of reverse flows.

DIRECT SALES TO CUSTOMERS The Internet allows manufacturers and other members of the supply chain that do not have direct contact with customers in traditional channels to get cus­tomer feedback and build a relationship with the customer. Social networking channels such as Facebook and Twitter allow firms to pitch products and promotions directly to customers.

FLEXIBLE PRICING, PRODUCT PORTFOLIO, AND PROMOTIONS Given the ease of changing prices and assortments online, the Internet allows a company selling online to manage revenues from its available product portfolio much more effectively than do traditional channels. Promo­tion information can be conveyed to customers quickly and inexpensively using the Internet as long as the business has access to its customer network. Groupon is one company that has used social networking online to push promotions to customers.

EFFICIENT FUNDS TRANSFER The Internet and cell phones can enhance the convenience and lower the cost of revenue collection, especially in small amounts. For example, after the earth­quake in Haiti in 2010, Mercy Corps transferred $40 automatically into each Haitian person’s account, allowing him or her to buy food at local merchants. This was much more efficient than handing out cash or vouchers.

2. Impact of Online Sales on Cost

Online sales affect the cost of inventory, facilities, transportation, and information. It is important to observe that the impact in each case is not necessarily positive.

INVENTORY Online sales can lower inventory levels by aggregating inventories far from cus­tomers if most customers are willing to wait for delivery. For example, Amazon is able to aggre­gate its inventory of books at a few warehouses. Barnes & Noble, in contrast, needs more inventory because it must carry a significant portion of its stock at retail stores. A key point to note is that the relative benefit of aggregation is small for high-demand items with low variability but large for low-demand items with high variability.

Online sales can lower a firm’s inventories if it can postpone the introduction of variety until after the customer order is received. The time lag between when a customer places the order and when he or she expects delivery offers a company selling online a window of opportunity to imple­ment postponement. For example, for its online business, Dell keeps its inventory as components and assembles its servers after receiving the customer order. The amount of component inventory required is much lower than it would be if Dell kept its inventories in the form of assembled servers. Similarly, Amazon prints some low-volume books to order, allowing it to reduce inventories.

FACILITIES Two basic types of facilities costs must be included in the analysis: (1) costs related to the number and location of facilities in a network and (2) costs associated with the operations that take place in these facilities. A company selling online can reduce network facility costs by centralizing operations, thereby decreasing the number of facilities required. For example, Netflix is able to satisfy demand for DVD rentals from about 50 warehouses, whereas Blockbuster needed thousands of retail outlets to serve customers.

With regard to ongoing operating costs, customer participation in selection and order placement allows a company selling online to lower its resource costs relative to staffing retail stores. Online sales can also lower a firm’s order fulfillment costs because it does not have to fill an order as soon as it arrives. A retail store or supermarket must staff its sales counters so more cashiers are available when more customers are shopping. As a result, these stores require greater staffing during peak periods. With online sales, if a reasonable buffer of unfilled orders is main­tained, the rate of order fulfillment can be made significantly smoother than the rate at which orders arrive, which reduces the peak load for order fulfillment and thus reduces resource require­ments and cost.

On the downside, however, for some products, such as groceries, online sales require the firm to perform tasks currently performed by the customer at retail stores, affecting both han­dling and transportation costs. In such situations, companies selling online will incur higher handling and delivery costs than a retail store. For example, whereas a customer picks out the required items at a grocery store, an online seller such as Peapod incurs higher handling costs because its employees must pick a customer’s order from the warehouse shelves and deliver it to the customer’s home.

TRANSPORTATION The Internet has significantly lowered the cost of “transporting” information goods in digital form, such as movies, music, and books. For nondigital products, aggregating inven­tories increases outbound transportation relative to inbound transportation. Compared to a business with many retail outlets, an online seller with aggregated inventories tends to have higher transporta­tion costs (across the entire supply chain) per unit because of the increased outbound costs.

INFORMATION An online seller can share demand information throughout its supply chain to improve visibility. The Internet may also be used to share planning and forecasting information within the supply chain, further improving coordination. This helps reduce overall supply chain costs and better match supply and demand. Here we see that information is an enabler of many of the benefits of online sales discussed so far.

A company selling online incurs additional information costs, however, to build and main­tain the information infrastructure. For example, when Amazon purchased Zappos, it had to add about 120,000 product descriptions and more than 2 million photographs to its website.

The blank B2C online sales scorecard shown in Table 4-9 can be used by a firm to sum­marize the impact of online sales on each of the areas identified earlier.

The value of setting up online sales is not the same in every industry. Whereas Amazon and Blue Nile have shown increased profits after going online, Webvan and many other online gro­cers have gone out of business. The scorecard in Table 4-9 can be used to understand how online sales affect the performance of different supply chain networks. In the next section, we apply the online sales scorecard to several examples.

3. Using Online Sales to Sell Computer Hardware: Dell

After more than a decade of tremendous success selling its products only online, Dell started to sell its consumer products through retail stores such as Walmart in 2007. However, it continued to sell its servers only online. Since about 2005, Apple has had considerable success selling its phones and computers through retail stores. This raises the question of the relative value of the online channel and retail stores for selling computer hardware.

To make this comparison, we compare Dell’s supply chain for servers and laptops. Prior to 2007, both servers and laptops were configured to order in Dell factories. By 2014, servers were configured to order, but laptops, whether sold through retail stores or online, were typically assembled well in advance of the final sale. We use our framework to understand why servers and laptops are better handled through different channels.

IMPACT OF ONLINE SALES ON CUSTOMER SERViCE FOR COMPUTER HARDWARE One dis­advantage for Dell of selling hardware over the Internet is the delay in fulfilling the customer request. Whereas a longer response time is not a big negative for customized servers, it is a dis­advantage for Dell when trying to sell its standardized laptops online.

Dell is able to exploit most of the responsiveness-enhancing opportunities offered by the Internet for customized servers. The company uses the Internet to offer a wide variety of custom­ized server configurations with the desired chassis, processor, memory, and operating system. Customization allows Dell to satisfy customers by giving them a product that is close to their specific requirements. The customization options are easy to display over the Internet, allowing Dell to attract customers who value this choice. Clearly, all these capabilities are not as valuable for standardized laptops.

The Internet allows companies such as Dell and Apple to bring new products to market quickly. This is particularly important in the computer and cell phone industries, in which many products have short life cycles of a few months. Whereas the Internet allows a new product to be offered as soon as it is produced, the retail channel requires the entire supply chain to be stocked before customers can access the product.

The Internet channel has allowed companies like Dell to make price changes quickly and efficiently based on product availability and demand. By being available all day, the online chan­nel allows Dell to serve customers at a much lower cost than retail stores.

IMPACT OF ONLINE SALES ON COST IN THE HARDWARE INDUSTRY

Inventory Costs. Its online sale of servers offers Dell the ability to reduce its invento­ries by aggregating them in a few geographic locations. Dell is able to further reduce inventories by postponing assembly of servers until after the order arrives. This allows Dell to hold invento­ries of components instead of finished goods.

Observe that inventory reduction through aggregation and postponement is much more valuable for customized servers with low and unpredictable demand compared with standardized laptops with large and predictable demand.

Facility Costs. The online channel allows the Dell supply chain to lower facility costs relative to the retail channel because Dell incurs only the cost of the manufacturing facility and warehousing space for components. A bricks-and-mortar retail chain must pay for the distribu­tion warehouses and retail stores as well.

Dell is also able to take advantage of customer participation and save on the cost of call center representatives because customers do all the work when they place an order online. Once again, the overall savings are greater for customized servers compared with standardized laptops.

Transportation Costs. As a result of online sales, total transportation costs in the Dell supply chain are higher than in a supply chain selling hardware through distributors and retailers. Whereas the transportation cost increase is a small fraction of the cost of a high-end customized server, it can be a large fraction of the cost of a low-end standardized laptop.

Information Costs. Although Dell has made a significant investment in information technology (IT) to implement its build-to-order model, the majority of these IT costs would be incurred regardless of Dell’s online sales status. Therefore, online sales do add incrementally to Dell’s information costs, but this is not a significant factor given the benefits. The value of the information infrastructure, however, is greater for a customized server relative to a standardized laptop.

IMPACT OF ONLINE SALES ON PERFORMANCE AT DELL As summarized in the online sales scorecard in Table 4-10, online sales allow Dell to significantly improve its performance for cus­tomized servers in terms of both responsiveness and cost. For standardized laptops, however, the online channel is significantly less attractive because its main strength—inventory reduction through aggregation—is not as valuable for standardized configurations. Simultaneously, the weaknesses of the online channel—poorer responsiveness and higher transportation costs— become more significant for standardized configurations.

A TAILORED SUPPLY CHAIN NETWORK FOR HARDWARE USING RETAIL STORES AND THE INTERNET It may seem, at first glance, that selling hardware online has significant advantages. A careful study, however, indicates that a hybrid model combining retail stores and the online channel can be very effective. The online channel is most effective for selling new products or customized hardware configurations whose demand is hard to forecast, with the retail channel selling low-cost, standard configurations whose demand is easier to forecast. Even for standard­ized products, manufacturers should introduce new models on the Internet; as demand for some of them grows, these models should be added to the retail channel. Another option is to introduce recommended configurations of new models at retail stores, while selling all customized con­figurations on the Internet. The manufacturer is thus able to decrease inventories by aggregating all high-variability production and satisfying that demand online. These models should be built to order using as many common components as is feasible. The standard models can be produced using a low-cost approach even if it involves longer lead times. Selling standardized models through distributors and retail stores allows the supply chain to be more responsive and save on transportation costs, which are more significant for these configurations.

A hardware manufacturer can use the tailored approach outlined earlier to take advantage of the strengths of both online sales and traditional retail and distribution channels. Gateway failed in its effort with retail stores because it did not use any of the supply chain strengths of the bricks-and-mortar channel. Instead of just helping people with configuration at its retail stores, Gateway would have served its customers better by also carrying recommended configurations of its computers in the stores. This would have immediately satisfied customers who wanted the recommended configuration, while allowing Gateway to produce the more customized configu­rations efficiently. In contrast, Apple has been very successful with its retail channel because it sells a relatively low variety of standardized hardware in large volumes at its stores. Dell has also started using the tailored approach with customized hardware such as servers built to order, whereas standardized hardware, such as laptops, is produced in low-cost countries and sold through retail stores such as Walmart. In the long run, a tailored approach is likely to prevail in the computer hardware and cell phone industry.

4. Using Online Sales to Sell Books: Amazon

Book supply chains have been transformed with the advent of online sales and the launching of Amazon.com in July 1995. Since then, Amazon has added many categories to its product offer­ings, including music, toys, electronics, software, and home improvement equipment. Whereas the Internet provided some advantage to Amazon for the sale of physical books, this advantage has magnified with the growth in electronic books (e-books).

IMPACT OF ONLINE SALES ON CUSTOMER SERVICE IN THE BOOK INDUSTRY Online sales have not helped profits for traditional books to the same extent as in the customized hardware industry. Unlike the hardware industry, in which online sales facilitate direct sales by manufac­turers, the Internet has not shortened supply chains in the book industry.

For traditional books, Amazon can attract only customers who are willing to wait a few days to get a book. Amazon also cannot attract customers who value the ability to leaf through books. The company tries to counter this problem by providing reviews and other information on books to allow customers to get a feel for the book online.

To counter these drawbacks, Amazon has exploited several opportunities on the Internet to attract customers and increase revenues. Amazon attracts many customers by offering a selection of millions of books. Customers can search for hard-to-find books or those of special interest. A large physical bookstore, in contrast, can carry fewer than a hundred thousand titles. Amazon also uses the Internet to recommend books to customers based on their purchase history. Amazon also provides reviews and comments from other customers on the titles available. New titles are quickly introduced and made available online, whereas in a bricks-and-mortar bookstore chain, all retail stores must be stocked.

Amazon uses the Internet to allow customers to order a book at any time from the comfort of their own homes and have it delivered to their door. This fact allows Amazon to attract cus­tomers who value this convenience and are willing to wait for delivery.

For e-books, Amazon is able to gain greater advantage using the online channel. For exam­ple, customers can download a book in seconds without having to leave home. For people who value time, this experience is superior to buying a traditional book either online or at a bookstore. Product availability is never an issue with e-books, and variety can be added at low marginal cost. In fact, the Internet has allowed the availability of books that are not guaranteed a high enough demand to make them viable for traditional publishers. For very-low-volume books, there is no better channel than online as e-books.

COST impact of online sales ON the book industry Amazon also uses online sales to lower its inventory and some of its facility costs. For traditional books, transportation costs increase as a result of selling books online. For e-books, however, transportation cost is not a factor given that they can be downloaded efficiently on the Internet.

Inventory Costs. Amazon is able to decrease inventories by aggregating physical inven­tories in a few geographical locations. A bookstore chain, in contrast, has higher inventories because titles are carried at every store. The reduction of inventories from aggregation is most significant for low-demand books with high demand uncertainty. The benefit is less significant for best sellers, for which demand is more predictable. Amazon carries medium- to high-demand titles in inventory, but it purchases low-demand titles from publishers in response to a customer order. In some instances, Amazon also prints very-low-volume titles with print-on-demand technology. This allows the Amazon supply chain to further reduce inventories of low-demand titles. For e-books, Amazon incurs no inventory costs because e-books do not have to be stored physically.

Facility Costs. Its online sales allow Amazon to lower facility costs because it does not need the retail infrastructure that a bookstore chain such as Barnes & Noble must have. Initially, Amazon did not have a warehouse, purchasing all books from distributors. When demand vol­umes were low, the distributor was a better location to carry inventories because it aggregated demand across other booksellers besides Amazon. As demand has grown, however, Amazon has opened its own warehouses, where it stocks books. Thus, facility costs at Amazon are growing, although they are still much lower than the facility costs for a bookstore chain. For e-books, Amazon needs server capacity to ensure that downloads are quick, but the investment in server capacity is likely to be cheaper than that for the warehousing required to serve physical demand.

Transportation Costs. The Amazon supply chain incurs higher transportation costs than does a bookstore chain selling through retail stores. Local bookstores do not have the cost of individually shipping books to customers. Amazon, in contrast, incurs the cost of shipping books to its customers from warehouses. The shipping cost from an Amazon warehouse represents a significant fraction of the cost of a book (it can be even higher than 100 percent for an inexpen­sive book). As demand has grown, Amazon has opened several warehouses in an effort to get closer to customers, decrease its transportation costs, and improve response time. Transportation costs at Amazon in 2012 were more than $5 billion; after accounting for transportation revenue, the net loss on outbound transportation was $2.85 billion, a very significant amount. In contrast, the cost of delivering e-books and other digital content to customers is negligible in comparison.

Information Costs. Setting up online sales for books takes some additional investment in IT, but is not prohibitively expensive. The cost of IT infrastructure to support download of e-books, however, is more expensive.

impact of Online Sales on Performance at Amazon. Amazon’s online sales score­card is summarized in Table 4-11. A comparison of Tables 4-10 and 4-11 shows that online sales offer far greater advantages when selling customized computer hardware than when selling physical books. This fact is explained by the following key differences between the two prod­ucts: (1) product differentiation in hardware can be postponed until after the customer has placed an order, whereas physical books are currently published well in advance of a sale and (2) trans­portation cost represents a much higher portion of the cost of books and a relatively small portion of the cost of hardware. For e-books, however, the Internet offers tremendous advantage relative to traditional bookstores. Amazon has pushed hard after the release of the Kindle, its e-reader, to encourage customers to buy books online.

Other digital content that Amazon sells includes movies, software, and music. In each instance, the Internet channel offers tremendous advantage relative to physical distribution. With the growth of iTunes at Apple and online sales at Amazon, retail chains built on selling physical formats of music had a difficult time surviving, with most closing by 2010. In the movie busi­ness, large DVD retailers like Walmart have continued to do well, but smaller retail formats such as Blockbuster have not survived selling and renting physical DVDs.

A TAILORED SUPPLY CHAIN NETWORK FOR BOOKS USING RETAIL STORES AND THE INTERNET In the 1980s, large bookstore chains such as Borders and Barnes & Noble established themselves at the expense of mom-and-pop bookstores primarily through aggregation. Large retail footprints allowed the two chains to carry a greater variety of books while often achieving lower costs than the small bookstores. Both Borders and Barnes & Noble carried a greater vari­ety but charged full price for low-demand books, while they offered a discount on best sellers. Such an approach was effective until Amazon established a dominant position. Amazon uses the Internet to sell low-volume books much more efficiently than either bookstore chain. With the growth in e-books and other retail formats such as Walmart and Costco selling best sellers, the large bookstore chains are stuck in the middle without any area of dominance. Large book­store chains are being squeezed from both ends: other retail formats for best-selling books and online sales for other low-volume books and e-books. Borders was shut down and liquidated in 2011 and Barnes & Noble was facing significant challenges.

5. Using the internet to Sell Groceries: Peapod

The grocery industry saw a spurt in new online sellers in 1998 and l999, although virtually all have gone out of business. Peapod, one of the oldest online grocers, is one of the few left. Given this industry’s poor track record, one might surmise that this is an industry not well suited for online sales. Despite the lack of success in this industry, though, Amazon has launched AmazonFresh and Tesco has pushed hard into online sales in the United Kingdom and South Korea. Let us take a look with our scorecard to see where, if at all, the Internet offers an advantage in this industry.

Peapod started by using employees at grocery stores to pick and deliver orders. The com­pany has now moved to supplying orders from centralized fulfillment centers in Chicago and Washington, D.C., and from large supermarkets with adjacent “warerooms” in other areas. Each fulfillment center is much larger than a supermarket and is comparable to a warehouse. The Peapod and supermarket supply chains are comparable except that Peapod must deliver goods to the customer, whereas the customer comes to a supermarket.

IMPACT OF ONLINE SALES ON CUSTOMER SERVICE IN THE GROCERY INDUSTRY Peapod and other online groceries have tried to sell convenience and time savings to potential custom­ers. For many people, grocery shopping is a chore that is time consuming and rarely enjoyable.

Peapod allows customers to place orders at any time and have them delivered at home, eliminat­ing a trip to the supermarket. This can be a significant convenience, especially in urban areas, where customers must walk to a supermarket and carry all their groceries home. In a suburban area, the benefit is smaller because people tend to batch their shopping and can drive to super­markets with relative ease. The convenience of saving time, however, remains quite valuable.

The convenience factor related to access is even more significant if a specialty-food pro­vider goes online. Specialty and ethnic food stores are not as accessible as supermarkets, and people often drive long distances to reach them. Offering these foods on the Internet provides easy access to customers and saves a long drive. Most large supermarkets offer sufficiently large variety to cover the needs of most households. Peapod, however, offers less variety than a typical supermarket.

Peapod is able to increase revenues by creating a personalized shopping experience for customers and delivering customized, one-to-one advertising and promotions. This is done using extensive member profiles that Peapod creates based on online shopping behavior, purchase his­tories, and surveys. Unlike a supermarket, in which the store does not know what customers have selected until they check out, Peapod can guide online customers based on what they purchase. For example, if a customer buys some pasta, Peapod can suggest a type of pasta sauce or some Parmesan cheese. Over longer periods, Peapod can collect shopping patterns and suggest prod­ucts that match a customer’s preferences. Such suggestions enhance revenues by increasing cus­tomers’ impulse purchases.

Peapod also adds to its revenues by giving consumer goods companies a forum for targeted interactive advertising and electronic coupons. Consumer choice data available to an online gro­cer is more valuable than scanner data from a supermarket because scanner data reveals only the customer’s final purchases. An online grocer, in contrast, can record the customer’s decision process by, for example, recording a customer’s substitution patterns for items that are out of stock. With scanner data, a supermarket cannot record substitutions because it has no way of finding out whether the customer looked for something that is out of stock.

IMPACT OF ONLINE SALES ON COSTS IN THE GROCERY INDUSTRY Peapod and other online grocers use online sales to lower some facility costs and, to an extent, inventory costs. Picking costs and transportation costs, however, are much higher than for traditional supermarkets.

Inventory Costs. Compared with a supermarket chain, an online grocer such as Peapod can lower inventories by aggregating the inventory in a few large replenishment centers. The degree of aggregation, however, is less than that achieved by Amazon for books or Dell for hard­ware, because Peapod needs fulfillment centers in every urban area it serves to get food to cus­tomers in acceptable condition.

The benefits of aggregation are further diminished by the fact that the majority of products sold at a supermarket are staple items with steady demand. Thus, aggregation provides a small benefit in terms of improved forecast accuracy and reduced inventories (see Chapter 12). The benefits of aggregation are higher for specialty, low-demand items with high demand uncer­tainty. These products constitute a small fraction of overall sales at a supermarket. Thus, aggre­gation allows e-grocers to lower their inventory costs only marginally compared with a typical supermarket. If online grocers focused primarily on specialty items such as ethnic foods, the inventory benefits of aggregation would be larger.

Facility Costs. Peapod’s online sales allow it to lower facility costs because it needs only warehouse facilities and can save on the cost of retail outlets such as supermarkets. Processing costs at Peapod to fulfill an order, however, are significantly higher than those for a supermarket and overwhelm the savings from needing fewer facilities. Peapod saves on checkout clerks com­pared with a supermarket but must pick the customer order, a task the customer performs at a supermarket and one that is much more time consuming than checkout. Thus, online sales result in a loss of customer participation compared to a supermarket and raise overall facility costs.

Transportation. An online grocer such as Peapod has significantly higher transporta­tion costs than a supermarket. Supermarkets have the advantage of having to bear only inbound transportation cost for products, with customers providing transportation from the supermarket to their homes. Inbound transportation costs tend to be low because supermarkets have large deliveries that enable them to exploit economies of scale in transportation. Peapod, in contrast, must bear inbound transportation cost to its fulfillment centers and then outbound delivery costs from the fulfillment centers to customer homes. Outbound delivery costs are high, because indi­vidual orders must be delivered to each customer’s home. The task becomes all the more prob­lematic given the different temperature requirements for different types of food.

Compared with computers and even books, groceries have a low value-to-weight/volume ratio. For example, paper towels and bathroom tissues have very low value but occupy a lot of space in a truck. Thus, transportation costs are a significant fraction of the cost incurred by online grocers. This makes it difficult for an online grocer to compete with a supermarket on prices.

Information Costs. Again, the IT infrastructure required for online sales increases costs. In the case of an online grocer, this is somewhat more significant than with the other online channels, because an online grocer takes on a wider range of functions that shoppers do them­selves. Therefore, IT costs are higher for an online grocer. As in the other examples, however, IT costs are not a deal breaker for this business model.

IMPACT OF ONLINE SALES ON PERFORMANCE AT PEAPOD Online sales offer some reve­nue-enhancement opportunities in the grocery industry. Costs, however, are significantly higher for an online grocer than for a supermarket, as we can see from Table 4-12. A comparison of Tables 4-10, 4-11, and 4-12 shows that online sales offer fewer benefits when selling groceries compared with books and computer hardware. Supermarkets are large enough to enjoy most of the inventory benefits that aggregation offers, without having the additional delivery cost incurred by an online grocer. Online grocers cannot compete with supermarkets on price and can succeed only if there are enough people willing to pay a premium for the convenience of home delivery.

Online grocers, however, can provide some cost advantage when selling specialty groceries, whose demand tends to be low and uncertain.

A TAILORED SUPPLY CHAIN FOR GROCERIES Traditional supermarket chains can benefit by using the online channel to complement the strengths of their existing networks. The online channel can be used to offer convenience to customers who are willing to pay for it. Supermar­kets can be used to target customers who value lower prices.

A supermarket chain with online sales has the opportunity to offer an entire array of services at differing prices based on the amount of work the customer does. The cheapest service involves customers walking into the supermarket and shopping for the products they want. In this case, the customer picks the order from the shelves and provides outbound transportation for it. For an addi­tional charge, a supermarket might allow customers to place orders online to be picked up at a later time. The supermarket personnel would pick the order from the shelves, but the customer would provide outbound transportation. The most expensive service involves the customer placing orders online for home delivery. In this case, the supermarket chain is responsible for both picking the order from the shelves and delivering it to the customer’s home. The varying services and prices would allow supermarket chains to efficiently satisfy the needs of a variety of customers.

Among the supermarket chains, Tesco has taken the lead in combining online sales with physical supermarkets to serve customers in a variety of ways. Customers could shop at a super­market, order online for home delivery, or pick up from a designated location. Traditionally, Tesco picked groceries at existing supermarkets for home delivery. By 2012, however, Tesco had opened several “dark stores” in London that were not open to the public but were used primarily to fill online orders. Rather than open large warehouses, Tesco preferred to serve online orders from these dark stores. Tesco intended to open more dark stores in London and other cities. Tesco had also experimented with other innovative models in Asia. In South Korea, Tesco targeted the large number of smartphone users by opening its first virtual store in the Seoul subway in August 2011. The glass walls of subway stations were covered with pictures of products laid out as they would be in a traditional supermarket. The “shelves” contained QR codes that could be scanned by a smartphone to build up a shopping basket quickly. If the train arrived before shopping was com­plete, commuters could continue to fill their shopping basket using a traditional mobile app. Deliveries were arranged to arrive in time for the commuter to cook dinner that evening.

6. Using the internet to Rent Movies: Netflix

Founded in 1997, Netflix had grown to more than 35 million subscribers by 2013 and was the world’s largest subscription service sending DVDs by mail and streaming movies and television episodes over the Internet. For $7.99 a month, customers could obtain unlimited streaming of Netflix’s digital library, and for another $7.99 per month, they could have any of more than 100,000 DVD titles delivered to their home by mail. The growth of Netflix was one of the major factors that drove DVD rental chain Blockbuster into bankruptcy in 2010.

Impact of online Sales on Customer Service for netflix Netflix attracted customers with its staggering selection and an excellent recommendation engine that allowed customers to access a list of titles they were likely to enjoy. Whereas a typical Blockbuster store offered 3,000 titles, Netflix had more than 100,000 titles available. Netflix claimed that 95 percent of its customers received their DVDs within 24 hours of shipping. In February 2000, Netflix introduced CineMatch, a program that made recommendations based on a customer’s rental history and preferences coupled with ratings from other users with similar interests. Netflix had more than 3 billion movie ratings from members, with about 4 million movies being rated per day. The rating system had proved to be especially accurate, and 60 percent of all Netflix users selected their movies based on recommenda­tions tailored to their individual tastes.¹ The company used its recommendation technology to keep the DVD shipments moving and a greater number of its older DVD titles in circulation.

For its digital content, Netflix allowed video streaming through a variety of devices, including set-top boxes from Roku, Microsoft Xbox, Sony Play Station 3, and high-definition televisions from Sony and LG. The use of the Internet to view digital content had grown at a considerable rate. It was estimated that 48 percent of customers watched more than 15 minutes of streaming content in the fourth quarter of 2009, up from 28 percent the previous year.^[1] This proportion was likely to grow in the future.

A challenge for Netflix was the delay the studios wanted to build in before allowing new movies to be available from Netflix. Given that the studios gained more revenue from DVD sales than from rentals, they had negotiated a four-week delay from when the DVD was first available for sale to when it was available on Netflix. This was an artificial delay designed to support DVD sales through outlets like Walmart.

IMPACT OF ONLINE SALES ON COSTS AT NETFLIX Netflix used the Internet to significantly lower its facility and inventory costs relative to Blockbuster.

Inventory Costs. Netflix aggregated its inventory at about 60 distribution centers in 2010. This allowed Netflix to hold significantly less inventory than Blockbuster, which held most of its inventory at thousands of retail stores. In 2009, about 70 percent of the DVDs shipped by Netflix were titles with release dates older than 13 weeks.^[2] Movie studios were happy that customers could view their older catalogs (which otherwise provided little revenue) and thus offered Netflix these DVDs at cost and shared in the revenue that Netflix earned. Not having to pay for older DVDs further lowered inventory costs at Netflix. In 2009, Netflix carried only $37 million in inventories (on sales of $1.67 billion), whereas Blockbuster carried $639 million in inventories (on sales of $4.06 billion).

Facility Costs. Netflix had significantly lower facility costs than Blockbuster because it aggregated its operations in fewer than 60 distribution centers, whereas Blockbuster had thou­sands of stores it had to pay for. Whereas $266 million in property and equipment at Netflix sup­ported $1.67 billion of sales in 2009, Blockbuster required $2.37 billion in property and equipment to support $4.06 billion of sales.

Transportation Costs. Transportation costs at Netflix were considerably higher than at Blockbuster. The Netflix CFO was quoted as stating that the company spent about $600 mil­lion in shipping DVDs in 2010. As people moved from DVDs to streaming, transportation costs were likely to decrease. In fact, Netflix’s strategy was to buy more digital content, using its sav­ings in transportation costs as subscribers moved toward watching more content online.

Information Costs. Information costs are higher to support the Netflix operations rela­tive to Blockbuster. With the growth in digital streaming, information costs are likely to increase.

IMPACT OF ONLINE SALES ON PERFORMANCE AT NETFLIX Netflix has significant advan­tages in renting movies compared with physical distribution channel of Blockbuster as shown in Table 4-13. These advantages are most pronounced for the wide selection of older movies that studios have in their catalogs. These advantages could become bigger as more content is streamed. However, as Netflix switches to being primarily a streaming service, it will face strong competition from the likes of Amazon, Apple, Google, and Hulu. The primary challenge for the streaming supply chain is sourcing content because the supply chain has relatively low invest­ment in other assets. Netflix will find it harder to maintain a competitive advantage in this space, unlike its competition with Blockbuster.

A TAILORED SUPPLY CHAIN FOR RENTING MOVIES Whereas Netflix is ideally designed through its centralized model to supply a wide variety of older movies (either by DVD or stream­ing), Redbox has used DVD vending machines to provide a low-cost channel for recent releases. These vending machines carry only a few hundred titles, consisting of new movies and popular children’s videos. They allow customers to go online and reserve movies at specific machines using a credit card. The result is a virtual aggregation of inventories, which improves the match­ing of supply and demand and reduces inventory expense. The vending machines are typically installed in existing retail infrastructure, such as grocery stores. Thus, the marginal increase in PP&E is small. The tailored combination of Redbox providing recent releases from vending machines and Netflix providing a wide variety of titles from a centralized model was able to provide both recent releases and a wide assortment at a much lower cost than Blockbuster’s try­ing to do both at its stores.

Source: Chopra Sunil, Meindl Peter (2014), Supply Chain Management: Strategy, Planning, and Operation, Pearson; 6th edition.