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Stock Planning for Specialty Goods at Zegema Retail

Case

Author: Abihlash G. Nambudiri Online Pub Date: January 02, 2018 | Original Pub. Date: 2018 Subject: Retailing, Operations Management, Strategic Decision-Making Level: Intermediate | Type: Experience case | Length: 3682 words Copyright: © Abhilash G. Nambudiri 2018 Organization: Zegema Retail Ltd | Organization size: Large Region: Southern Asia | State: Industry: Retail trade, except of motor vehicles and motorcycles Originally Published in: Publisher: SAGE Publications: SAGE Business Cases Originals DOI: http://dx.doi.org/10.4135/9781526430892 | Online ISBN: 9781526430892

© Abhilash G. Nambudiri 2018

This case was prepared for inclusion in SAGE Business Cases primarily as a basis for classroom discussion or self-study, and is not meant to illustrate either effective or ineffective management styles. Nothing herein shall be deemed to be an endorsement of any kind. This case is for scholarly, educational, or personal use only within your university, and cannot be forwarded outside the university or used for other commercial purposes. 2019 SAGE Publications Ltd. All Rights Reserved.

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Abstract

Zegema Retail, an organized retail outlet, faces a decision dilemma regarding sourcing and mer- chandising processes for its specialty food items, which are high margin and low volume SKUs. This case reviews the challenges involved in sourcing, merchandising, and stock planning for these specialty SKUs at hypermarkets, large-scale stores in the Zegema chain found in major cities where a large influx of tech workers from different regions creates a demand for com- fort food. A merchandising manager responsible for a Zegema region must determine the best sourcing plan and arrive at an optimal stock planning process that meets the needs of customers and his store managers. This case provides an opportunity for participants to discuss reorder- point based stock planning and its effect on stocking decisions.

Case

Learning Outcomes Participants in this case discussion will:

• identify the complexities involved in sourcing and merchandising high margin and low volume stock keeping units (SKUs) in general and specialty SKUs in particular;

• investigate options for setting up a specialty SKU supply chain; • examine decisions for choosing one sourcing option over another; • become familiar with stock planning models and related calculations.

Introduction Rajesh, the merchandising manager at Zegema Retail, was concerned about a call he received from his boss, Akash, vice president of merchandising. During the subsequent meeting, Akash showed a text message from Bhavdeep, the CEO, about the stock-out situation for specialty food items at a Zegema hypermarket. Akash was unsatisfied with the way Zegema handled the specialty goods section: supplies were highly erratic from vendors, specialty SKUs were frequently out of stock, and specialty SKUs had a higher proportion of dam- aged stock returns or write-offs compared to normal SKUs. With these issues at hand, Akash wanted Rajesh to implement a sustainable mechanism for sourcing and stock planning.

Overview Founded in 2004, Zegema Retail was one of the first organized retail companies of India. In 2015, Zegema had a turnover of INR 16.72 billion1 with retail operations across 35 major cities in India.

The IT revolution (1991)2 in India had created a new kind of mobile workforce, willing to relocate from their hometowns to distant places. A large number among this mobile work force is very particular about their food habits and other day-to-day needs, based on such factors as their ethnicity and place of origin. With 29 states across India and many ethnic groups, traditions and food habits are diverse. A software engineer from Chen-

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nai in southern India who resides in Delhi, in northern India, would want Appalam3 for lunch. Similarly, a pro- fessional from western India working in the south would love to have Dhokla4 occasionally. Hence, Zegema stores in north India considered Appalam a specialty item, while in the south it was considered standard. Like- wise, Zegema in south India considered Dhokla a specialty item, while stores in western India considered it standard.

Specialty Goods Specialty goods have been defined as products used extensively by customers in a specific geography/com- munity, but that have lesser or no relevance in other regions or among other ethnic communities of the coun- try. Specialty goods are a low volume, high margin product. These are typically called “range-builders” in an organized retail context.

The emergence of a young and mobile Indian workforce and their specific needs created this new specialty segment. Their needs were largely unmet in the current retail environment where small and unorganized spe- cialty stores spread across the city. These stores targeted customers of a particular region or ethnicity, offer- ing a limited SKU range. The sourcing and logistics were handled directly by shopkeepers who received stock through parcel service with Indian Railways.

The small stores were able to sustain profits for two reasons: (a) customers were willing to pay full price for the products and did not expect discounts or promotions, and (b) as the SKU range was limited, stores could do tight inventory control and provide the best variety to customers. However, to target diverse customers in a multi-store and geographically wide environment, was both logistically and operationally a difficult task.

Zegema Retail By 2015, Zegema Retail had over 12.5 million square feet of trading area, and its management focused on becoming the largest and preferred organized retail chain in India. Zegema sought the help of a business- consulting firm to create a strategic roadmap for its growth plans. The consulting firm came up with three recommendations for growth and profitability:

• Concentrate only on large format stores and drive volume. • Convert merchandising vertical into a profit center from the existing cost center. • Create a “Food-First” image among target customers.

Referring to the Food-First brand image, Bhavdeep, the CEO of Zegema, said:

“We always knew our strength was in the food category. With a strong merchandising team handling the entire gamut of food combined with an efficient network of vendors across India, we had the right ingredients to delight customers in the food category.”

Zegema Retail was about to launch its first hypermarket in Gurgaon, a city in northern India, by October 2015. Rajesh was the Regional Merchandising Manager (RMM) and hence responsible for all sourcing and mer- chandising activities, including for specialty items. The store launch was critical for the entire organization as it was the first hyper store in the northern region. Bhavdeep, Akash, Rajesh, and the entire top management team visited the regional office frequently to oversee launch activities. The city was a main IT hub with a cos- mopolitan customer base. Initial market research confirmed strong regional preferences in food, clothing, and religious rituals. Bhavdeep had once mentioned in a pre-launch review that he would like to see the new store

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become a destination for the specialty needs of Gurgaon residents, irrespective of their places of origin.

With over 150,000 square feet of trading area, the store would be one of the biggest hypermarkets for Zegema Retail. On completion, it would carry almost all categories of daily products including grocery, fast moving consumer goods (FMCG), vegetables and fruits, home decor, automobile accessories, and consumer elec- tronics.

Specialty Goods at Zegema Zegema Retail, headquartered at Kolkata in eastern India, had already introduced the concept of specialty SKUs. The specialty initiative catered only to the demands of one specific set of customers: select stores stocked only south Indian specialty SKUs. The assortment of SKUs was minimal, with 20 SKUs sold at three Hyper stores. One vendor supplied the SKUs directly to stores and also operated a stand-alone south Indian specialty retail store at Tolligunj, 20 km away from Zegema.

Since there were few specialty SKUs and sales were not significant, these SKUs were replenished manually, thus keeping the process out of the auto-replenishment model in the ERPS (enterprise resource planning so- lution). After receiving a mail order from stores, the local Zegema buyer created electronic purchase orders and sent them to the vendor through mail. Typical lead-time for such an order was three days to a week.

Customer support staff at stores with specialty SKUs were local residents who were not familiar with the SKUs. They also lacked product knowledge about the SKUs and often considered them a low priority.

According to the merchandising manager for the Kolkata region:

“We tried to aggregate specialty SKUs from other regions through Zegema’s existing logistics net- work. Damage was a major concern when SKUs had to travel long distances. As a large number of SKUs were from the food category, product expiration before reaching the destination was another issue. Zegema’s own regional merchandising team did not cooperate in sending these SKUs from their respective region to Kolkata. Hence, for such specialty items we had to rely on local vendors or SKU aggregators.”

Some specialty SKU aggregators could deliver end-to-end services for managing specialty SKU sourcing and logistics for Zegema (Table 1). None of the aggregators, however, could handle more than one type of spe- cialty SKU.

Table 1: Vendor Details for Specialty Item Supply (Aggregators)

Vendor Name Specialty Kind SKU Range

Margin % (Mark Down) Damage Policy Delivery

Aarti suppliers Bengali Food 10 for all SKUs All damage back within 5 days Store delivery

DS enterprises Rajasthani Food 18 for all SKUs No damage return Delivery to distribu-tion center only

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Karla mer- chants Rajasthani

Food & non-food 10 for all SKUs

All damage back within 5 days Store delivery

Kanhayyalal Co. Rajasthani

Food & non-food 17.50 for all SKUs No damage return

Delivery to distribu- tion center only

Mangalmoorthy stores Rajasthani

Food & non-food 10 for all SKUs

All damage back within 5 days Store delivery

Das Brothers Bengali Food 20 for all SKUs No damage return Delivery to distribu-tion center only

Mac Enterpris- es

South In- dian

Food & non-food

10 to 15% based on category No damage return

Delivery to distribu- tion center only

Source: Internal company sources (author’s personal files).

Store Operations at Zegema Zegema had four store formats, from largest to smallest, Hyper, Super, Daily, and Express. Stores with over 15,000 square feet of trading area were Hyperstores. In all store types, floor space was allocated equally among food and non-food categories, and between a Hyper and an Express, SKU assortment fell progres- sively. Tables 2 and 3 show a comprehensive merchandising snapshot of Zegema Retail.

Table 2: Merchandising Format at Zegema Stores

Hyper Super

Trading area >15,000 square feet 5000–15,000 square feet

Categories carried

Apparels, electronics, grocery, home care, packaged food, beverages, small furniture, sports accessories, footwear, fresh vegetables, meat, fish, live food counters, specialty goods, and alcoholic drinks

Grocery, home care, pack- aged food, beverages, fresh vegetables, meat, fish, and specialty goods

Total num- 70,000–100,000 ~35,000

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ber of SKUs

Specialty item avail- ability

YES, a minimum of specialty items from 3 regions YES, a maximum of specialty items from 2 regions based on store catchment

Space al- location for spe- cialty

Minimum of 5 retail racks Maximum of 2 retail racks

Table 3: Comparable Normal SKU (Packaged Food) vs Specialty SKU

Hyper store (1#) Super store (1#)

Normal SKUs Specialty SKUs Normal SKUs Specialty SKUs

Margins 15–18% 10–15% 20–25% 10–15%

Lead time 2 days 10 days 2 days 10 days

Sales value/month INR 28 mil- lion5 ~ INR 1 million

6 INR 1.2 mil- lion INR 0.1 million

Inventory turnover Twice a week Once every month Once every week Once every month

Damage return <0.1% of total sales 10–15% of specialty SKU sales

<0.5% of total sales

10–15% of specialty SKU sales

Promotional support from vendors YES NO YES NO

Zegema used catchment analysis to understand customer needs and competition, a procedure all stores did

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once a month, sending the report to merchandising managers. Catchment analysis provided critical informa- tion about Zegema’s competitiveness on price and SKU assortment along with insights from existing cus- tomers to improve service offerings. For a Hyper, a 10 km radius from the store was the catchment area. The marketing team surveyed customers from randomly sampled households to collect data about shopping habits. Apart from these sources, Zegema also used published secondary data to understand the socioeco- nomic–cultural (SEC) profiles of the neighborhoods. Zegema’s supply chain consisted of a Distribution Centre (DC) situated in a suburban area, normally about 30 km away from the city and all vendors supplied to prod- ucts to that DC. Store distribution was done through Zegema’s own distribution vehicles based on an order processing IT system, Auto Replenishment System (ARS). Local vendors had a lead time of three days with a margin of error of one day. All of them were able to adhere to this once they received the purchase order from Zegema Retail.

Customer Expectations For customers, availability and assortment were more important than price or promotions on specialty SKUs. A specialty SKU sale would not drive volume business for Zegema. It would create more walk-ins to the store and build the image of a dependable food retailer in the minds of customers.

Rajesh recalled a conversation with a customer during catchment analysis. The customer worked with a major IT company, and he had lived in Gurgaon for the past three years. He was originally from Chennai. The cus- tomer said:

“There are a lot of south Indian people like me, staying in this city. All of us have a strong desire to eat our specialty foods, like Appalam, on a regular basis. Currently, all of us who stay inside the city travel close to 15 km in heavy traffic to get these specialty items from a store run by a migrant from Chennai. He charges high prices. I would really appreciate if an organized retailer like Zegema could provide those specialty SKUs under the same roof so that I can do my entire household shopping all at once from a single store.”

Other customers shared their expectations from Zegema in interviews: some customers even shared the names of a specific regional brand they wanted (Table 4). Customers indicated they were willing to pay a pre- mium for these specialty items.

Table 4: Sample List of Specialty Items Preferred by Consumers (Information Gathered Through Catchment Analysis)

South Indian specialty items Sakthisundavathal

777 Garlic rasam paste Sakthi chilly chutney powder

777 Idly chilli powder Sakthi curry leaf powder

777 Instant puliyodharai mix Sakthi dal powder

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777 Pepper rasam paste Sakthi egg guruma masala

777 Rice puliyodharai extract Sakthi fish fry masala

777 Vathalkuzhambu extract Sakthivathalpulikolambu powder

Aachi (branded pickles) Sakthi mutton masala

Brahmins (branded powders and pickles) Sakthirasam powder

Rangoli powder Sakthi sambar powder

Indulekha hair oil Eastern chicken masala

Dheedhi shampoo Eastern fish moly masala

Double horse netholiachaar Eastern fish curry powder

Doublehorsepalappampodi Eastern prawns achaar

Double horse palada Kolam powder

Bengali specialty items Dried fish (various varieties)

Jeerakati rice Soya bari

Gobindbhog rice (three main sizes) Soya powder

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Bashkati rice Engine mustard oil

Masoor gram (two types) Dhara mustard oil

Choorans from haldirams Panipuri powder

Murmura Chiwda

Marwari specialty items

Rajastaniamchur powder Rajastani jeera powder

Rajastanitikkhalal Hajmola candy

Rajastanibiyawarimircha Rajasthani jeera powder (seeka)

Rajastanimethi powder Rajastanimakkapowa

Rajastani rai powder Rajasthanipudina powder

Rajastaniangari Rajastaniounth powder

Rajastanichilli flakes Soya bari

Rajastanigaram masala Keokarpin hair oil

Rajastanihinggota Various amchur sweats

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Rajastanijaipurimircha Rajastani jeera powder

Source: Internal company sources (author’s personal files).

As an attempt to gain more insight, Rajesh contacted some specialty stores in the city and visited them as a prospective buyer. All were ready to do business with Rajesh. All wanted to be assured of regular order quan- tities to sustain business. They offered margins at 10% across all categories of SKUs. They were also ready to take back damaged or expired stocks. They also assured a three-day delivery commitment with one-day allowance for unforeseen aspects of business and environment.

Suppliers (Specialty Aggregators) Even though some aggregators existed at the regional level, few vendors/aggregators could provide compre- hensive sourcing and delivery across all locations. There were several reasons for this: lack of economies of scale for vendors, SKUs had to travel a long distance from origin to destination, which made them vulnerable to spillage, damage and expiry, and most vendors were regional and could not offer full service supply and logistics support over long distances. The average lead time for a local vendor was about three days where- as for specialty SKU aggregators it would be between 12 and 15 days. For outstation vendors, there could be slight delays or early arrivals up to three days. Aggregators also tended to be very aggressive with credit terms; most wanted 15 days payment. In a discussion with Rajesh, one aggregator pointed out:

“I am a bit skeptical in taking orders for only one retailer for delivering these specialty goods. I have a problem with volume when catering to only one retailer. At the same time, I am not in a position to aggregate orders for more retailers, as others are not strategizing on delivering these specialty items to their customers as Zegema is. In order to be economically viable, I need to get a full truckload worth of purchase order each time from Zegema. This will approximately be INR 0.75 million. Also I have to manage logistics for aggregating and supplying over very long distances and be prepared for damage losses. For example, south Indian specialties sourced from Chennai need to travel about 1600 km in order to reach Kolkata. Somebody will have to pay the cost of delivering this added val- ue to the customers. If a retailer is not willing to compromise on margins for compensating a large number of other SKUs, how do they expect an aggregator or a vendor to compromise?”

Store Manager Expectation Store managers in the Zegema system were responsible for overall store performance: for the top line, bottom line, and operational discipline of the store. Key Result Areas (KRA) included sales turnover, gross margin, shrinkage7, shelf cleanliness8, space planning adherence, human resource turnover, foot traffic, and bills cut on a monthly basis. Store managers were not responsible for margins on any individual category or SKU, only for overall store margins. They controlled the sale of an SKU below cost (negative margin). Store managers also played a pivotal role in identifying and mapping the right kind of specialty SKUs for the store, based on catchment analysis. Rajesh knew that the only way to create buy-in from store managers for his solution to tackle specialty SKU issues was by making the process simple, involving fewer transactions for them. One store manager said to Rajesh:

“I am not very keen on having these specialty items in my store, especially when it is from other Zegema regions. Last time it created more problems than benefits to the store performance. In my past experience, all packets of the specialty SKUs we received were damaged. We were not able to

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sell most of the products and they went directly into my shrinkage account as a loss. As I remember, there was a 5–6% hit (reduction) on my store margin for that particular month. To make things worse, replenishment of these SKUs never happened. Customers often came back to the store for those SKUs and found the specialty racks empty. They complained many times about not getting their fa- vorite specialty SKUs that were available earlier. These incidents, in turn, created a bad reputation to my store and had serious consequences on the store image.”

Distribution Process at Zegema Zegema used a “hub and spoke model” of distribution. It segregated SKUs into two categories, flow-through9

and put-away10. This segregation happens at the Distribution Center (DC). Generally, low shelf-life items were classified as flow-through items and the rest as put-away.

For another mode of supply called ‘direct store delivery’ mode, vendors supplied directly to the designated stores and the Goods Receipt Note (GRN) was generated at the store rather than at DC. SKUs such as milk, bread, eggs, and leafy vegetables were delivered through direct store delivery. Store managers ordered di- rectly from vendors and took the stock into the store. Store managers preferred direct store delivery as it offered more stock control. Zegema management, however, discouraged this mode because of reconciliation issues. Store delivery of SKUs needed the manual supervision of the store manager. Excess store delivery of SKUs would make it un-manageable for store managers because their valuable time will be lost in too much of unproductive work.

In the past, Zegema had tried to ensure a seamless supply of specialty goods with sustainable product mar- gins, by using local specialty vendors to deliver specific SKUs. Rajesh articulated the challenge at hand:

“I can either choose to get specialty supplies from a local vendor or third party SKU aggregators. But the issue is whether vendors can deliver value to Zegema in terms of range of SKUs and reli- ability with adequate fill rates on the shelf. Even then the last mile distribution to stores had to be thought through well. I also need to take care of damage, and the arrangements to compensate for the same. Small local vendors cannot take damage losses on their accounts. The key question is whether Zegema has the negotiating power with third party SKU aggregators to absorb damage re- turns into their account.”

Expansion and Plans Based on the recommendations of the consulting firm, Zegema started to expand its footprint in India by adding large format Hyper stores. Zegema identified business hot spots in all major Indian cities and collabo- rated with property developers for aggressive geographic expansion.

After discussions with colleagues, Rajesh realized he had another option to manage the logistics and mer- chandising of specialty goods. He could use other regions of Zegema Retail as dummy aggregators and use Zegema’s own logistic system to transport specialty SKUs from one region to another. But this option is not feasible if no Zegema stores exist in the region for a specialty SKU. Even then, the challenge of dealing with damage and stock returns was still an unsolved issue.

Discussion Questions

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1. What options for sourcing and stock planning can Rajesh choose to avoid a stock-out sit- uation in future?

2. What kind of products are specialty goods? What model for inventory planning is optimal for such products?

3. Outline the challenges Zegema faces to implement the proposed stock-planning model. How can they overcome those challenges?

4. What assumptions are made for Zegema stock-planning analysis? If any of those as- sumptions are negated, will your decision change? Explain.

Notes 1. $ to INR conversion on November 10, 2015 (when this case was originally written) was 66.14.

2. Ankelesaria Aiyar, S. S. (2002). What enabled the software revolution in India. Times of India, 28 April. Retrieved from http://timesofindia.indiatimes.com/business/india-business/What-enabled-the-software- revolution-in-India/articleshow/8188397.cms

3. Appalam is a ready-to-fry food item made out of black gram is a traditional food in southern parts of India. Appalam, which is familiar in Tamilnadu, is a specialty food which expands nearly double the size after frying and is very puffy and salty.

4. A steamed cake made out of gram flour along with some spices and sweeteners.

5. Standard deviation of sales for normal SKU = ~ INR 0.2 million (data from discussion with store managers)

6. Standard deviation of sales for specialty SKU = ~ INR 7000 (data from discussion with store managers).

7. Unaccounted wastage calculated as (Quantity delivered to store – Quantity sold – Quantity in stock) * Cost Price,

8. Measured using mystery shoppers.

9. SKUs that were supplied by the vendors at the DC and dispatched to the respective stores based on pre- fixed allocation rule on the same day.

10. SKUs that were supplied by the vendors at the distribution center and kept in DC till the order gets gener- ated from any particular store. According to the order generated from the store, it gets picked and dispatched to the store.

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