Designing distribution networks and applications to online sales

The role of distribution in the supply chain

Distribution refers to the steps taken to move and store a product from the supplier stage to a
customer stage in the supply chain. Distribution occurs between every pair of stages in the
supply chain.

Raw materials and components are moved from suppliers to manufacturers, whereas finished
products are moved from the manufacturer to the end consumer.

Distribution is a key driver of the overall profitability of a firm because it affects both the supply
chain cost and the customer value directly.

The process of designing a distribution network has two broad phases. In the first phase, the
broad structure of the supply chain network is visualized. This phase decides the number of
stages in the supply chain and the role of each stage.

The second phase then takes the broad structure and converts it into specific locations and their
capability, capacity, and demand allocation.

The appropriate distribution network can be used to achieve a variety of supply chain objectives
ranging from low cost to high responsiveness. As a result, companies in the same industry often
select different distribution networks. An inappropriate network can have a significant negative
effect on the profitability of the firm. The appropriate choice of distribution network grows the
supply chain surplus by satisfying customer needs at the lowest possible cost.

Factors influencing Distribution network Design

At the highest level, performance of a distribution network should be evaluated along two
dimensions:

1. Value provided to the customer

2. Cost of meeting customer needs

By comparing different distribution network options, a firm must evaluate the impact on
customer service and cost. The customer needs that are met influence the company’s revenues,
which, along with cost, decide the profitability of the delivery network.

Although customer value is affected by many factors, we focus on measures that are influenced
by the structure of the distribution network:

Response time: Response time is the amount of time it takes for a customer to receive an order.

Product variety: Product variety is the number of different products or configurations that are
offered by the distribution network.
 Designing distribution networks and applications to online sales

Product availability: Product availability is the probability of having a product in stock when a
customer order arrives.

Customer experience: Customer experience includes the ease with which customers can place
and receive orders and the extent to which this experience is customized.

Time to market: Time to market is the time it takes to bring a new product to the market.

Order visibility: Order visibility is the ability of customers to track their orders from placement
to delivery.

Return ability: Return ability is the ease with which a customer can return unsatisfactory
merchandise and the ability of the network to handle such returns.

Changing the distribution network design affects the following supply chain costs:

Inventories: As the number of facilities in a supply chain increases, the required inventory
increases. To decrease inventory costs, firms try to consolidate and limit the number of facilities
in their supply chain network.

Transportation: 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. 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 transportation cost, as
shown in Figure 4-3. If the number of facilities is increased to a point at which inbound lot sizes
are also very small and result in a significant loss of economies of scale in inbound
 Designing distribution networks and applications to online sales

transportation, increasing the number of facilities increases total transportation cost, as shown in
Figure 4-3.

FIGURE 4-3 Relationship Between Number of

Facilities and Transportation Cost

Facilities and handling: Facility costs decrease as the number of facilities is reduced because a
consolidation of facilities allows a firm to exploit economies of scale.

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.

FIGURE 4-4 Relationship Between Number FIGURE 4-5 Variation in Logistics Cost and
of Facilities and Facility Costs Response Time with Number of Facilities

Information:
 Designing distribution networks and applications to online sales

Design Options for a Distribution Network

Managers must make two key decisions when designing a distribution network:

1. Will product be delivered to the customer location or picked up from a prearranged site?
2. Will product flow through an intermediary (or intermediate location)?

Based on the firm’s industry and the answers to these two questions, one of six distinct
distribution network designs may be used to move products from factory to customer. These
designs are classified as follows:

1. Manufacturer storage with direct shipping

2. Manufacturer storage with direct shipping and in-transit merge
3. Distributor storage with carrier delivery
4. Distributor storage with last-mile delivery
5. Manufacturer/distributor storage with customer pickup
6. Retail storage with customer pickup

Manufacturer Storage with Direct Shipping

In this option, product is shipped directly from the manufacturer to the end customer, bypassing
the retailer (who takes the order and initiates the delivery request). This option is also referred to
as drop shipping. The retailer carries no inventory. Information flows from the customer, via the
retailer, to the manufacturer, and product is shipped directly from the manufacturer to customers,
as shown in Figure 4-6.

FIGURE 4-6 Manufacturer Storage with Direct Shipping

Online retailers such as e-Bags and Nordstrom use drop-shipping to deliver goods to the end
consumer. E-Bags hold few bags in inventory. Nordstrom carries some products in inventory
 Designing distribution networks and applications to online sales

and uses the drop-ship model for slow-moving footwear. W.W. Grainger also uses drop-shipping
to deliver slow-moving items to customers.

The benefits from centralization are highest for high-value, low-demand items with
unpredictable demand.

Thus, drop-shipping does not offer a significant inventory advantage to an online grocer selling a
staple item such as detergent. For slow-moving items, inventory turns can increase by a factor of
six or higher if drop-shipping is used instead of storage at retail stores.

Given its performance characteristics, manufacturer storage with direct shipping is best suited for
a large variety of low-demand, high-value items for which customers are willing to wait for
delivery and accept several partial shipments. Manufacturer storage is also suitable if it allows
the manufacturer to postpone customization, thus reducing inventories. It is thus ideal for direct
sellers that are able to build to order. For drop-shipping to be effective, there should be few
sourcing locations per order.

The performance characteristics of drop-shipping along various dimensions are summarized in

Table 4-1.

Manufacturer storage with direct shipping and in-Transit Merge

In-transit merge combines pieces of the order coming from different locations so the customer
gets a single delivery. Information and product flows for the in-transit merge network are shown
 Designing distribution networks and applications to online sales

in Figure 4-7. In-transit merge has been used by Dell and can be used by companies
implementing drop-shipping.

Figure 4-7 In-Transit Merge Network

This approach has the greatest benefits for products with high value whose demand is difficult to
forecast, particularly if product customization can be postponed.

Although an increase in coordination is required, in-transit merge decreases transportation costs

relative to drop-shipping by aggregating the final delivery.

The main advantages of in-transit merge over drop-shipping are lower transportation cost and
improved customer experience. The major disadvantage is the additional effort during the merge
itself.

It is best suited for low- to medium-demand, high-value items the retailer is sourcing from a
limited number of manufacturers. When there are too many sources, in-transit merge can be
difficult to coordinate and implement. In-transit merge is best implemented if there are no more
than four or five sourcing locations.
 Designing distribution networks and applications to online sales

Distributor storage with Carrier Delivery

Under this option, inventory is held not by manufacturers at the factories, but by distributors/
retailers in intermediate warehouses, and package carriers are used to transport products from the
intermediate location to the final customer. Information and product flows when using distributor
storage with delivery by a package carrier are shown in Figure 4-8.

Figure 4-8 Distributor Storage with Carrier Delivery

 Designing distribution networks and applications to online sales

Amazon and industrial distributors such as W.W. Grainger and McMaster-Carr have used this
approach combined with drop-shipping from a manufacturer (or distributor).

From an inventory perspective, distributor storage makes sense for products with somewhat
higher demand.

Transportation costs are somewhat lower for distributor storage compared with those for
manufacturer storage because an economic mode of transportation (e.g., truckloads) can be
employed for inbound shipments to the warehouse, which is closer to the customer. Here
distributor storage allows outbound orders to the customer to be bundled into a single shipment,
further reducing transportation cost.

The information infrastructure needed with distributor storage is significantly less complex than
that needed with manufacturer storage.

Response time under distributor storage is better than under manufacturer storage because
distributor warehouses are, on average, closer to customers, and the entire order is aggregated at
the warehouse before being shipped.

Distributor storage with carrier delivery is well suited for slow- to fast-moving items. Distributor
storage also makes sense when customers want delivery faster than is offered by manufacturer
storage but do not need delivery immediately. Distributor storage can handle somewhat lower
variety than manufacturer storage but can handle a much higher level of variety than a chain of
retail stores.
 Designing distribution networks and applications to online sales

Distributor storage with last-Mile Delivery

Last-mile delivery refers to the distributor/retailer delivering the product to the customer’s home
instead of using a package carrier. The warehouse storage with last-mile delivery network is as
shown in Figure 4-9.

Figure 4-9 Distributor Storage with Last-Mile Delivery

 Designing distribution networks and applications to online sales

Amazon, Fresh, Peapod, and Tesco have used last-mile delivery in the grocery industry.

The automotive spare parts industry is one in which distributor storage with last-mile delivery is
the dominant model. It is too expensive for dealers to carry all spare parts in inventory. Thus,
original equipment manufacturers tend to carry most spare parts at a local distribution center
typically located near their dealers and often managed by a third party. The local distribution
center is responsible for delivering needed parts to a set of dealers and makes multiple deliveries
per day.

From an inventory perspective, warehouse storage with last-mile delivery is suitable for
relatively fast-moving items that are needed quickly.

Among all the distribution networks, transportation costs are highest for last-mile delivery,
especially when delivering to individuals.

Manufacturer or Distributor storage with Customer pickup

 Designing distribution networks and applications to online sales

In this approach, inventory is stored at the manufacturer or distributor warehouse, but customers
place their orders online or on the phone and then travel to designated pickup points to collect
their merchandise. Orders are shipped from the storage site to the pickup points as needed.

Figure 4-10 Manufacturer or Distributor Warehouse Storage with Consumer Pickup

Examples include 7dream.com and Otoriyose-bin, operated by Seven-Eleven Japan, which allow
customers to pick up online orders at a designated store.

Inventory costs using this approach can be kept low, with either manufacturer or distributor
storage to exploit aggregation.

Transportation cost is lower than for any solution using package carriers because significant
aggregation is possible when delivering orders to a pickup site.

Facility costs are high if new pickup sites have to be built.

A significant information infrastructure is needed to provide visibility of the order until the
customer picks it up. Good coordination is needed among the retailer, the storage location, and
the pickup location.

The main advantages of a network with consumer pickup sites are that it can lower the delivery
cost and expand the set of products sold and customers served online. The major hurdle is the
increased handling cost and complexity at the pickup site. Such a network is likely to be most
effective if existing retail locations are used as pickup sites.
 Designing distribution networks and applications to online sales

Retail storage with Customer pickup

In this option, often viewed as the most traditional type of supply chain, inventory is stored
locally at retail stores. Customers walk into the retail store or place an order online or by phone
and pick it up at the retail store.

Examples of companies that offer multiple options of order placement include Walmart and
Tesco.

Local storage increases inventory costs because of the lack of aggregation.

Transportation cost is much lower than with other solutions because inexpensive modes of
transport can be used to replenish product at the retail store.

Facility costs are high because many local facilities are required.

A minimal information infrastructure is needed if customers walk into the store and place orders.
For online orders, however, a significant information infrastructure is needed to provide visibility
of the order until the customer picks it up.
 Designing distribution networks and applications to online sales

Good response times can be achieved with this system because of local storage.

The main advantage of a network with retail storage is that it can lower delivery costs and
provide a faster response than other networks. The major disadvantage is the increased inventory
and facility costs. Such a network is best suited for fast-moving items or items for which
customers value rapid response.

Selecting a Distribution network Design

A network designer needs to consider product characteristics as well as network requirements

when deciding on the appropriate delivery network. In Table 4-7, the various delivery networks
are ranked relative to one another along different performance dimensions.
 Designing distribution networks and applications to online sales

Most companies are best served by a combination of delivery networks. The combination used
depends on product characteristics and the strategic position that the firm is targeting. The
suitability of different delivery designs (from a supply chain perspective) in various situations is
shown in Table 4-8.
 Designing distribution networks and applications to online sales

Discuss the impacts of online sales on distribution network

The impacts of online sales on distribution network can be explained considering two case: how
online sales affect a supply chain’s ability to meet customer needs and the cost of meeting those
needs.

Impact of online sales on Customer service

Online sales affect various factors of customer service which are discussed below:

1. 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. The Internet has facilitated
almost instantaneous access to movies, music, and books in digital form.
2. Product Varity: A company selling online finds it easier to offer a larger selection of
products than a store. Offering the same selection at a store would require a huge location
with a correspondingly large amount of inventory.
3. 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.
 Designing distribution networks and applications to online sales

4. 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.
Online sales also allow a firm to access customers who are geographically distant.

The Internet offers an opportunity to create a personalized buying experience for each
customer. Firms that focus on mass customization can use the Internet to help customers
select a product that suits their needs. For both consumers and companies, online sales
can increase the ease with which one does business.

5. 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.
6. 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.
7. Return ability: Return ability is harder with online orders. It is much easier to return a
product purchased at a retail store.
8. 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.
9. Flexible pricing, product portfolio, and promotions: 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.
10. Efficient funds Transfer: The Internet and cell phones can enhance the convenience and
lower the cost of revenue collection.

Impact of online sales on Cost

Online sales affect the cost of inventory, facilities, transportation, and information.

Inventory: Online sales can lower inventory levels by aggregating inventories far from
customers if most customers are willing to wait for delivery. 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.
 Designing distribution networks and applications to online sales

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.

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.

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.

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.

Transportation: The Internet has significantly lowered the cost of “transporting” information
goods in digital form, such as movies, music, and books. For no digital 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.

A company selling online incurs additional information cost to build and maintain the
information infrastructure.