Supply Chain Frontiers issue #54
A premium coffee company in China has an extensive distribution network that delivers product seven days a week. Yet the average daily stock-out rate in stores located in high-density urban areas is 40% for food items. How can the company fix this supply chain problem, which in addition to causing lost sales is damaging customer loyalty?
Masoud Khakdaman tackled the problem in his Master of Science degree in Supply Chain Management thesis project at the Malaysia Institute for Supply Chain Innovation (MISI). Khakdaman, a graduate of the Class of 2014, won the Best Student Thesis award for his research. The thesis was supervised by Dr. Ioannis N. Lagoudis.
The research looked at the delivery of food service items to stores in Beijing. Four food types that generate 55 SKUs were sold in 122 stores. It became apparent that the root causes of the stock-out issues lay in the company’s distribution and transportation system.
Khakdaman simulated the distribution system using AnyLogic Simulation software, and came up with four alternative strategies.
1. Add a delivery run from the company’s central distribution center (CDC) to city stores before demand peaked
The company made one daily delivery from the CDC to stores early each morning, even though many outlets were out of product by noon. Adding another delivery before this time decreased stock-out levels by around 16% and decreased lost sales opportunity costs from $528,000 to $ 312,000. Importantly, this option did not require a change in the configuration of the supply chain network. In the deficit column is the fact that this strategy increased total supply chain cost.
2. Add a regional distribution center (RDC) supplied by the CDC
The RDC would be located within Beijing’s city limits. Delivery times between the RDC and stores were almost half of those for the existing, CDC-centric model, leading to a drop in stock-outs from 40% to just 18%. Opportunity costs fell to $235,000. In addition, this configuration is the easiest to manage because the company is responsible for the full delivery cycle. However, like the first option, this one increased total supply chain costs dramatically. It would require the company to make a significant capital investment in a new distribution facility.
3. Add an RDC supplied by both the CDC and suppliers
This is a variation on the second strategy, in that the RDC is fed by suppliers in addition to the CDC. Bringing suppliers into the equation gives the company more flexibility and choice. On the other hand, supplier deliveries take more time and add complexity compared to the second option. Stock-out levels are improved only by a relatively modest 7%. This strategy also introduces more cost.
4. Close the CDC and add two RDCs
This option calls for a fundamental change in the way the company’s distribution network is configured. Two RDCs located in Beijing replace the existing CDC. The new facilities supply all the stores, order from suppliers independently, and use third-party logistics providers to execute shipments. This option has the longest transportation lead time, and that has a negative impact on fulfillment. The fourth strategy is the only one that negatively affects both on-shelf availability and opportunity cost.
The analysis shows that the second alternative is the optimum one: adding a single RDC supplied by the CDC. It achieves the best improvement in stock-out levels, and although transportation costs rise, the extra cost is more than offset by the revenues gains. In fact, supply chain profitability increases by 37% under this scenario.
However, the first option – simply adding one more delivery run – might garner the most support, because it does not require any significant change in the current distribution network. Also, this option increases demand fulfillment by 16% while improving profitability by 28%.
Finally, a change in mindset is recommended as a result of the research findings. The company should consider lost sales as a critical component of total supply chain costs.
For more information on this thesis and MISI’s Master of Science degree in Supply Chain Management program, contact MISI Communications Director David S.Baylis at dbaylis@misi.edu.my.