Brief Discussion

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Chapter 4 • Designing Distribution Networks and Applications to Online Sales 71

To decrease inventory costs, firms try to consolidate and limit the number of facilities in their supply chain network. For example, with fewer facilities, Amazon is able to turn its inventory about 10 times a year, whereas Barnes & Noble, with hundreds of facilities, achieves only about 3 turns per year.

Inbound transportation costs are the costs incurred in bringing material into a facility. Outbound transportation costs are the costs of sending material out of a facility. Outbound transportation costs per unit tend to be higher than inbound costs because inbound lot sizes are typically larger. For example, an Amazon warehouse receives full truckload shipments of books on the inbound side, but ships out small packages with only a few books per customer on the outbound side. Increasing the number of warehouse locations decreases the average outbound distance to the customer and makes outbound transportation distance a smaller fraction of the total distance traveled by the product. Thus, as long as inbound transportation economies of scale are maintained, increasing the number of facilities decreases total trans- portation cost, as shown in Figure 4-3. If the number of facilities is increased to a point where inbound lot sizes are also very small and result in a significant loss of economies of scale in inbound transportation, increasing the number of facilities increases total transportation cost, as shown in Figure 4-3.

Inventory Costs

Number of Facilities

FIGURE 4-2 Relationship Between Number of Facilities and Inventory Costs

Transportation Cost

Number of Facilities

FIGURE 4-3 Relationship Between Number of Facilities and Transportation Cost

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Chapter 4 • Designing Distribution Networks and Applications to Online Sales 71

To decrease inventory costs, firms try to consolidate and limit the number of facilities in their supply chain network. For example, with fewer facilities, Amazon is able to turn its inventory about 10 times a year, whereas Barnes & Noble, with hundreds of facilities, achieves only about 3 turns per year.

Inbound transportation costs are the costs incurred in bringing material into a facility. Outbound transportation costs are the costs of sending material out of a facility. Outbound transportation costs per unit tend to be higher than inbound costs because inbound lot sizes are typically larger. For example, an Amazon warehouse receives full truckload shipments of books on the inbound side, but ships out small packages with only a few books per customer on the outbound side. Increasing the number of warehouse locations decreases the average outbound distance to the customer and makes outbound transportation distance a smaller fraction of the total distance traveled by the product. Thus, as long as inbound transportation economies of scale are maintained, increasing the number of facilities decreases total trans- portation cost, as shown in Figure 4-3. If the number of facilities is increased to a point where inbound lot sizes are also very small and result in a significant loss of economies of scale in inbound transportation, increasing the number of facilities increases total transportation cost, as shown in Figure 4-3.

Inventory Costs

Number of Facilities

FIGURE 4-2 Relationship Between Number of Facilities and Inventory Costs

Transportation Cost

Number of Facilities

FIGURE 4-3 Relationship Between Number of Facilities and Transportation Cost

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Facility Costs

Number of Facilities

FIGURE 4-4 Relationship Between Number of Facilities and Facility Costs

72 Chapter 4 • Designing Distribution Networks and Applications to Online Sales

Facility costs decrease as the number of facilities is reduced, as shown in Figure 4-4, because a consolidation of facilities allows a firm to exploit economies of scale. While Amazon achieved a property, plant, and equipment turnover (PPET) of 19 in 2009, Barnes & Noble had a PPET of just over 7.

Total logistics costs are the sum of inventory, transportation, and facility costs for a supply chain network. As the number of facilities increases, total logistics costs first decrease and then increase as shown in Figure 4-5. Each firm should have at least the number of facilities that minimizes total logistics costs. Amazon has more than one warehouse primarily to reduce its logistics costs (and improve response time). If a firm wants to reduce the response time to its customers further, it may have to increase the number of facilities beyond the point that minimizes logistics costs. A firm should add facilities beyond the cost-minimizing point only if managers are confident that the increase in revenues because of better responsiveness is greater than the increase in costs because of the additional facilities.

Response Time

Number of Facilities

Total Logistics Cost

FIGURE 4-5 Variation in Logistics Cost and Response Time with Number of Facilities

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Facility Costs

Number of Facilities

FIGURE 4-4 Relationship Between Number of Facilities and Facility Costs

72 Chapter 4 • Designing Distribution Networks and Applications to Online Sales

Facility costs decrease as the number of facilities is reduced, as shown in Figure 4-4, because a consolidation of facilities allows a firm to exploit economies of scale. While Amazon achieved a property, plant, and equipment turnover (PPET) of 19 in 2009, Barnes & Noble had a PPET of just over 7.

Total logistics costs are the sum of inventory, transportation, and facility costs for a supply chain network. As the number of facilities increases, total logistics costs first decrease and then increase as shown in Figure 4-5. Each firm should have at least the number of facilities that minimizes total logistics costs. Amazon has more than one warehouse primarily to reduce its logistics costs (and improve response time). If a firm wants to reduce the response time to its customers further, it may have to increase the number of facilities beyond the point that minimizes logistics costs. A firm should add facilities beyond the cost-minimizing point only if managers are confident that the increase in revenues because of better responsiveness is greater than the increase in costs because of the additional facilities.

Response Time

Number of Facilities

Total Logistics Cost

FIGURE 4-5 Variation in Logistics Cost and Response Time with Number of Facilities

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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 seen their profits increase 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.

Using Online Sales to Sell Computer Hardware: Dell

The online channel has proved very effective for the sale of computer hardware and by 2009 represented about half the sales in this category. After more than a decade of tremendous success selling its PCs only online, Dell started to sell PCs through retail stores such as Wal-Mart in 2007. 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 each channel. As shown in Figure 4-11, when using the online channel, Dell typically starts assembly after receiving a

Chapter 4 • Designing Distribution Networks and Applications to Online Sales 89

Pull Retail Store

Dell

Supplier

Dell’s Retail Supply Chain

Customer

Dell

Supplier

Dell’s Online Supply Chain

Pull Customer

FIGURE 4-11 Supply Chains for Dell’s Online and Retail Channels

Table 4-9 The Online Sales Scorecard Area Impact

Response time

Product variety

Product availability

Customer experience

Time to market

Order visibility

Direct sales

Flexible pricing, portfolio, promotions

Efficient funds transfer

Inventory

Facilities

Transportation

Information

Key: +2 = very positive; +1 = positive; 0 = neutral; !1 = negative; !2 = very negative.

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