Virtual Fulfillment Path

Why hold goods in anticipation of orders if you can get someone else to do it for you? But upon closer examination, virtual order fulfillment proves to be something less than the silver bullet. The guidelines offered here will help both pure-play and brick-and-mortar companies determine which fulfillment path--virtual or traditional--is right for their online business.

Over the past five years, many companies have experimented with combining information technologies (such as electronic data interchange, enterprise resource planning, and the Internet) and sophisticated distribution techniques (hub-and-spoke configuration and cross docking) to create innovative supply chain structures. Perhaps the most striking development in this space is the dramatic increase in virtual order fulfillment, which is accomplished by the technique called drop shipping. With drop shipping, the retailer passes orders straight through to a wholesaler or manufacturer, which then ships products directly to customers with the retailer's label on the package. The retailer itself holds no inventory.

At first glance, the advantages of the virtual supply chain appear overwhelming. To illustrate, thriving CD retailer Spun.com avoided an $8 million investment in inventory by using the fulfillment capabilities of the wholesale distributor Alliance Entertainment Inc. Competitor CDNow, by contrast, which owns its inventory and fulfillment capabilities, has declared bankruptcy because it is unable to cover its costs of doing business. Yet other real-life examples fail to provide such clear-cut evidence of the virtual supply chain's comparative advantages. Online retailer Value America, for example, declared bankruptcy citing in part an inability to fill customer orders from virtual stocks. Value America's chief competitor, Amazon.com, on the other-hand, has aggressively invested in fulfillment capabilities and continues to garner high ratings for service. Most importantly, the online retail giant recently posted its first quarterly profit.

Benefits of choosing virtual inventories:
1. Reduced investment in inventory and fulfillment capabilities
2. Wider product selection
3. More predictable product availability
4. Lower costs due to economies of scale
5. Lower transportation costs

Costs of Virtual Inventories:

1. Loss of product margin
2. Loss of control that could negatively affect service quality
3. Encroachment on customers

Chooding a supply chain structure:
Higher sales volume favors the traditional structure
High need for order consolidation favors the traditional structure
Lack of small-order fulfillment capabilities among wholesalers favors the traditional structure
High demand volatility favors the virtual structure
High product variety favors the virtual sturcture

Inventory Planning in Rocket Science Retailing

Offering the right product in theright place at the right time for theright price is retaiiing's formula forperfection.The ideal rennains elusive,but an elite rank of retailers is gettingcloser to it every day.There's muchto be learned from what they do.

Some retailers (we'll refer to retailers and e-tailershenceforth with the broader term) have dramaticallyimproved their performance in ordering, distribution,and merchandising. But those companiesare still a small, elite rank. The next step? An industrywidemove toward something we call rocket scienceretailing - the act of blending traditional forecastingsystemLS, which are largely based on theintuition of a handful of employees, with the prowessof information technology. Rocket science retailingfuses data and instinct with computer modelsand analysis to create a high-tech forecastingsystem supported hy a flexihle supply chain.

Inventory planning involves deciding when andhow much to order, or how much to produce, ofvarious raw materials, components, and finishedgoods. Inventory planning differs from forecastingbecause a planner might find it beneficial to stockmore or less than predicted demand. In planninginventory for a household, for example, you mightdecide to stock far more medicine than you anticipateneeding in case you become sick. Or you mightbuy certain items - batteries, for instance - manymonths' demand at a time while other items-breadand milk, for instance - might be ordered everyweek. Inventory planning at most retailers suffersfrom several shortcomings. One of tbe most glaringis that many retailers don't track stockouts andtbe resulting lost sales. Only 15 of the 32 companiesin our study said they track stoekouts, and 11 of the 13 used this information to estimate the resultinglost sales.

Lost sales are endemic among retailers, especiallyfor products with short life cycles. Tracking stockoutscould help retailers set optimal inventory levelsand could help them see the value in improvingsupply-chain responsiveness. So why aren't thesemetrics studied carefully? One reason is that it'shard to know how much of a product would havesold if supply had been plentiful. The figure canbe estimated using sophisticated statistical techniques,but retailers generally can't find such capabilitiesin commercial software, especially in thecase of short-life-cycle products.

There is a way over that hurdle. We developed amethod to estimate lost sales. Our procedure worksin two steps. First, it calculates the underlying demandrate for a product based on the sales patternsthat occurred when the product was in stock. Second,it combines the estimated demand rate withthe duration of the product stockout at a particularstore to derive the lost sales. To estimate demandrate and lost sales, the technique has to be modifiedfor factors such as the variation of demand on differentdays and at different times within a day. Inour experiments with real retail data, our techniqueestimated lost sales to within 2% at the store leveland with higher accuracy at the chain level or for acategory of products.

The benefits of tracking lost sales, and increasing inventory levels systematically to reduce thoselosses, can be substantial. One retailer found thatsales could be improved by roughly io% simply byincreasing inventory at the stores, suggesting thatlost sales-before the inventory boost-would haveaccounted for at least io% of sales. At Rome-basedjewelry manufacturer Bulgari, stockouts on a singleitem at one store had been high enough to reducethe store's revenue hy 3.5%. As a result, Bulgari isseeking ways to improve its planning processes.

Order Batching

In a supply chain, each company places orders with anupstream organization using some inventory monitoringor control. Demands come in, depleting inven-tory, but the company may not immediately placean order with its supplier. It often hatches or accumulatesdemands hefore issuing an order. There aretwo forms of order hatching: periodic ordering andpush ordering.

Instead of ordering frequently, companies may order weekly, hiweekly, or even monthly. There are many common reasons for an inventory system based on order cycles. Often the supplier cannot handle frequent order processing because the time and cost of processing an order can be substantial. P&G estimated that, because of the many manual interventions needed in its order, billing, and shipment systems,each invoice to its customers cost between $35 and$75 to process. Many manufacturers place purchaseorders with suppliers when they run their material requirements planning (MRP) systems. MRP systems are often run monthly, resulting in monthly orderingwith suppliers. A company with slow-moving items may prefer to order on a regular cyclicalbasis becausethere may not be enough items consumed to warrantresupply if it orders more frequently.

Consider a company that orders once a month from its supplier. The supplier faces a highly erratic stream of orders. There is a spike in demand at onetime during the month, followed by no demands for the rest of the month. Of course, this variability is higher than the demands the company itself faces.Periodic ordering amplifies variability and contributesto the hullwhip effect.

One common obstacle for a company that wants to order frequendy is the economics of transportation.There are substantial differences between frill truckload truckload(FTL) and less-than-trucldoad rates, so companies have a strong incentive to fill a truckload when they order materials from a supplier. Sometimes, suppliers give their best pricing for FTL orders. For mostitems, a full truckload could be a supply of a monthor more. Full or close to ftill truckload ordering wouldthus lead to moderate to excessively long order cycles.

In push ordering, a company experiences regularsurges in demand. The company has orders "pushed"on it from customers periodically because salespeopleare regularly measured, sometimes quarterly or annually,which causes end-of-quarter or end-of-year ordersurges. Salespersons who need to fill sales quotas may"horrow" ahead and sign orders prematurely. TheU.S. Navy's study of recruiter productivity foundsurges in the numher of recruits by the recruiters on aperiodic cycle that coincided with their evaluation cycle/ For companies, the ordering pattern from theircustomers is more erratic than the consumption patterns that their customers experience. The "hockeystick" phenomenon is quite prevalent.

When a company faces periodic ordering by itscustomers, the bullwhip effect results. If all customers'order cycles were spread out evenly throughout theweek, the bullwhip effect would be minimal. The periodicsurges in demand by some customers would beinsignificant because not all would be ordering at thesame time. Unfortunately, such an ideal situation rarelyexists. Orders are more likely to be randomly spreadout or, worse, to overlap. When order cycles overlap,most customers that order periodically do so at thesame time. As a result, the surge in demand is evenmore pronounced, and the variability from the bullwhipeffect is at its highest.

If the majority of companies that do MRP or distributionrequirement planning (DRP) to generatepurchase orders do so at the beginning of the month(or end of the month), order cycles overlap. Periodic execution of MRPs contributes to the bullwhip effect,or "MRP jitters" or "DRP jitters."

Deep Thoughts by Nicholas C. Jacobs

The first article comparing JIT ordering vs. EOQ ordering was an interesting read, at least when you compare it to the other article with all the formulas. Once I saw all the formulas my eyes glazed over and had lost all interest in what the other was trying to say. Therefore, my thoughts on these readings will be mainly geared towards the first article that discussed JIT and EOQ.

I thought this article was an interesting read and was worth my time because it discussed the benefits and draw backs of the two systems, something that I have not seen presented in this manner. The author does a pretty good job of explaining when it would be beneficial to employ JIT ordering, as well as EOQ ordering principles. In the end the author mentioned that the best method may be some type of combination between the two, which would make sense.

However, this does lead me to ask one question, if the author is stating that in some instances EOQ may be a better method than JIT, then how come you never hear company's or industry experts talk about using this (at least I don't). In today's business environment, a lot of what you hear is focused on lean manufacturing principles, which include things like kanban systems, andon, five s, error proofing, TPM, JIT, and TQM, just to name a few, and what the company is doing to eliminate waste from its processes. But in everything that I have read discussing lean manufacturing, there is no mention ever of EOQ. Just about every article or book mentions JIT. If it is better to use in some instances, why isn't anyone else talking about it, or that company's should be doing this?

Grace's overview on JIT and EOQ Inventory Control Model

The article "A comparative analysis of inventory costs of JIT and EOQ purchasing" by Faraneh Fazel pretty much discusses how to make the decusion of whether or not switch to the just-in-time(JIT) purchasing policy. Traditional inventory management techniques many underemphasize the costs of maintaining inventories. JIT may underemphasize the costs of not maintaining invemtories, particularly since such costs are often difficult to identify and measure.

The author came up a mathematical model showing the cost difference(Z) between using EOQ and JIT. EOQ will be the less costly alternative for Z<0,>0. Meanwhile, for an item with a given demand, companies also can find the highest price that they can pay to purchase the item on a JIT basis and still be economically better off than using EOQ purchasing. This highest price can be obtained by setting Z=0. For prices higher than this highest price, Z will be negative, making EOQ a lower cost alternative. Determination of this price level provides valuable information for companies when negotiating a delivery price with their JIT suppliers.

First of all, the break-even demand is a function of EOQ and JIT delivery prices and inventory holding and ordering costs. Also, the lower the carring cost or the odering cost assciated with the EOQ model, the lower will be the point indifference between rhe JIT and EOQ models, and the wider the range of demand over which EOQ is cost effective. Secondly, the larger the premium the manufacturer pays for purchasing items on a JIT basis, the smaller the range of annual demand for which JIT is preferred. Thirdly, a choice between JIT and EOQ will impact the fixed costs. Certain fixed costs under EOQ, such as the costs associated with operating some storage facilities which include rental, utilities, and personnel salaries of these facilities, may be eliminated under JIT. Alao JIT purchasing significantly reduces the paperwork volume and saves time for purchasing personnel by using long-term contracts instead of multiple purchase orders and by sharing the buyer's production plans and schedules with trusted suppliers and integrating the suppliers into buyer's purchasing programme.

One thing to notice is that since the parameters establishing the break even point vary from one product to another, the most suitable purchasing policy in a given manufacturing environmrnt may well be a combination of both systems.