Professional Documents
Culture Documents
Sunil Chopra is the IBM Distinguished Professor of Operations Management and Jan Van Mieghem is an Associate
Professor of Operations Management; both are at the Kellogg Graduate School of Management at Northwestern University.
Both are co-authors of "Managing Business Process Flows" (Prentice Hall 1999). Professor Chopra also is the co-author
of the new textbook "Designing and Managing Supply Chain Flows," (to be published by Prentice Hall), which inspired this
article.
Copyright 2000. All rights reserved, contact s-chopra@kellogg.northwestern.edu.
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e-business and the supply chain
some instances, the Internet may shift the frontier by supply chain. For example, going online would benefit
significantly decreasing the cost for existing levels of an airline more than a travel agent.
performance. For example, at industrial supplier W.W. Providing on-line product and other
Grainger, e-business does not change any of the information across the supply chain allows flexibility on
underlying processes but makes them cheaper to execute. price, product portfolio and promotions. The Internet
This would mean that the main advantage from e- makes information located at a central source (the seller’s
business would be to increase efficiency by automating web server) available to anyone with Internet access, so
previous activities (i.e., substituting labor for capital). In that a change in price, product portfolio or promotions
other instances, such as the online grocer Peapod.com, only requires one database entry. A traditional mail order
the Internet primarily enhances convenience without company would need to mail new catalogs to all
significantly reducing costs. (Later on we will argue that customers to change prices or products. Using its e-
costs may actually increase.) In that case, the main business, however, L.L. Bean only needs to update the
advantage of the e-business would be to offer higher price on its website. This allows dynamic "revenue
value along a given customer need. Sometimes, e- management" where prices reflect actual demand and
business may shift the frontier out along both dimensions inventory positions, very much like airline yield
simultaneously, as is the case for Dell Computers that is management. For example, Dell uses the Internet to
able to deliver both higher customer value in terms of change prices and delivery times for different PC
customization and responsiveness, and lower process configurations regularly, based on demand and
cost. component availability.
On-line product information allows a much
faster time to market as a product can be "introduced" as
High Use Internet to soon as a first unit is available. This is particularly
enhance value valuable in industries with short product life cycles,
Product value
to customer
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e-business and the supply chain
customers to enhance revenues. Auctions sites like eBay separating fulfillment from order placement, an e-
and exchanges like Commerce One allow people to bid business can smooth the order fulfillment rate. This
for goods and services with different people potentially reduces the peak load for order fulfillment and thus
paying different prices. Other e-businesses offer resource requirements and costs. Finally, a direct-sales
customers a menu of services at different prices, allowing manufacturer can reduce handling costs because fewer
them to select the desired level of service. For example, supply chain stages are involved in the product flow to
Amazon.com provides a customer ordering multiple the customer.
books with shipping times for each book. Some titles Inventory costs: Many e-businesses can centralize
may be available for next day shipping while others inventories because they do not have to carry inventory
involve a weeklong lead-time. Customers can choose to close to the customer. This geographical centralization
receive one order after a week at a lower price, or reduces required inventory levels because of increased
separate shipments in order of availability at a higher economies of scale in the supply and reduced aggregated
price. variability in the demand. In some instances, given the
Global access at any time from any place in time lag between when an online order is placed and
terms of order placement allows an e-business to enhance filled, e-businesses can reduce inventories by postponing
revenues by attracting customers who may not be able to product differentiation until after the customer order has
place orders during regular business hours. For example, been placed. Postponing assembly or product
customers can place orders at industrial supplier differentiation allows a firm to "assemble to order"
Grainger.com, even when the Grainger stores where they customized products from common components.
will pick up their orders are closed. Grainer has observed Conceptually, postponement decreases the supply
a surge in online orders after their stores close. (Similar processes that are operated in "push" mode (i.e., in
access convenience may be important in Europe, where anticipation of a customer order, as shown in Figure 2)
many supermarkets are closed in the evenings, exactly the while it increases the processes that operate in "pull"
time when many customers that work could place their mode (i.e., after a particular customer order arrives). A
orders.) An e-business also allows a small specialty store major advantage of e-business is that, by separating
with one location near Chicago to reach customers ordering from fulfillment, increased flexibility in
worldwide. operations is gained to implement postponement. (It is
E-business can enhance revenues by speeding somehow ironic that by "going on Internet time," supply
up collection of funds. An example of speeding up chains may actually buy themselves time compared to
collection comes from the 2000 presidential campaign of traditional brick-and-mortar retailing where ordering and
John McCain. Within 48 hours of his primary victory in fulfillment tend to coincide.)
New Hampshire, Mr. McCain’s campaign collected $1
million over his website. Receiving $1 million in checks Customer Order and
Procurement cycle
would require much more time and effort to process and Manufacturing Cycle
collect them!
PUSH Processes PULL Processes
Cost Impact of E-business
time
In Designing and Managing Supply Chain Flows, it is
argued that the impact of e-business on supply chain
Customer order arrives Customer order filled
costs is better understood by considering the four drivers
of supply chain performance.
Facility costs include both site and processing costs. Figure 2: Push and Pull Processes
E-businesses are able to centralize facilities because
online sales allow the separation of order placement and Transportation costs. One should differentiate
order fulfillment. Site costs may decrease as direct inbound from outbound transportation: a firm incurs
customer-manufacturer contact and geographical inbound transportation costs to bring a replenishment
centralization eliminates or reduces retail sites. For order in from a supplier while it incurs outbound
example, Amazon supplies its customers from a few transportation costs to deliver the product to the
warehouses, while Borders and Barnes and Noble must customer. Typically, replenishment orders enjoy lower
incur facility costs for all their retail stores. In addition, unit transportation costs than customer orders because of
bookstores have a higher space cost per square foot and scale economies. Physical centralization increases the
lower asset utilization compared to warehouses. distance traveled by a customer order, while decreasing
An e-business can decrease processing cost if they the distance traveled by a replenishment order. Thus,
can increase the amount of customer participation. For compared to a business with several physical outlets, an
example, customers purchasing online from L.L. Bean e-business will tend to have higher transportation costs
do all the work of selecting the product, placing and per unit. Clearly, transportation costs are eliminated for
order, and paying. This is in contrast to a call center downloadable information goods.
where an employee is involved in the order process. In Information sharing improves supply chain
some instances, e-businesses may face higher processing coordination. An e-business can easily share demand
costs because they have to perform tasks currently and other information (such as inventory positions)
performed by the customer at a retail store. By across the supply chain to dampen the bullwhip effect
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e-business and the supply chain
and improve coordination. Sharing planning and • Outbound transportation to the customer is a small
forecasting information further improves coordination fraction of total product cost.
and reduces overall supply chain costs while better
matching demand with supply. Information processing Notice that all these conditions are satisfied by
costs also tend to be lower for an e-business if it has downloadable information goods: Facility costs are
successfully integrated systems across the supply chain. minimal as physical storage and personnel (handling &
management) requirements are minimal. Inventory
requirements vanish as one copy of the file on the server
A scorecard for e-business evaluation in the supply is sufficient. With a sufficient, non-depletable inventory
chain position of one, pull and postponement have no
incremental value and become irrelevant. Finally,
The different factors influenced by e-business are outbound transportation costs are minimal over the
summarized in a scorecard, as shown in Figure 3. By Internet. For example, it is much faster and less costly to
evaluating the impact on the various factors, one gains let customers download the prospectus of a mutual fund
insight in how e-business impacts a particular supply than to mail or fax it. In addition, downloadable
chain and whether this value can most easily be captured products also can exploit all the revenue opportunities.
by existing players or by new entrants. For example, if Thus, downloadable information goods are the perfect fit
opportunities mostly accrue on the revenue side of the to the e-business channel. For them, the Internet moves
scorecard, the e-channel may be best positioned as a the frontier out along both dimensions, increasing
value enhancement of the product offering. If, on the simultaneously efficiency and value. This, however, is
other hand, the e-channel mostly improves cost, a focus the exception to the "rule:" for non-downloadable
on efficiency may be more appropriate. products, most supply chains should make a clear choice
on the positioning of the e-channel. We illustrate this
At the danger of over simplification, the scorecard does with four examples: two of which are supply chains
suggest some key conditions for the supply chain to catering the consumer (business-to-consumer, or B2C),
exploit the maximum benefit of going on-line: while the other two are business-to-business (B2B)
• The supply chain is able to exploit all potential supply chains.
revenue enhancing opportunities of e-business
• Centralization significantly reduces facility costs. B2C in the Computer Industry: Dell Computer on-line
• Going on-line reduces processing costs.
• Centralization yields significant inventory benefits. The success story of how Michael Dell started selling
This is most likely if there are considerable computers directly to the consumer in 1984 has become a
economies of scale, or for new products or low- classic introduction to the direct business model, as it is
volume high-variety products, which have high called. Recently, the Internet has become a logical
demand uncertainty and benefit most from statistical extension of Dell's direct model. This becomes apparent
aggregation. by analyzing the scorecard of e-business in Dell's supply
• The supply chain can move processes to after a chain, as summarized in Figure 4.
customer has placed an online order. On the revenue side, the e-business channel
• The supply chain can postpone product continues Dell’s direct sales model with increased
differentiation. margins compared to a traditional computer manufacturer
with resellers. The ability to change prices and delivery
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e-business and the supply chain
times on the fly has been used effectively by Dell to (or already paid for), the input inventory is greatly
manage demand based on component availability. reduced by exploiting economies of scale and statistical
Related, the faster time to market for new product aggregation over the common components.
introductions is a considerable benefit when product life Similarly, high volumes of a relatively limited
cycles are measured in months. Having direct customer set of common inputs may reduce inbound transportation
contact allows Dell to provide customization and large costs, or even eliminate them if the supplier is co-located.
selection on their customer-specific Premier web pages. Perhaps the only negative cost impact of the e-channel is
It may allow customer-dependent service, such as pre- the increased outbound transportation costs to customers.
installed software images and priority routing, with Those, however, are relatively small when focusing on
accompanied customer-negotiated pricing. Moreover, higher-end computers and on high-volume corporate
through continuously updated "recommended accounts.
configurations," Dell can steer customers towards Thus, the opportunities of the e-business are
products that are in ample supply. Similarly, by sharing significant in the computer industry. To exploit them
dynamic inventory information with suppliers, Dell can well, the supply chain must move product customization
work both on the input and output ends of the supply to the pull phase and hold inventories as common
chain to match demand with supply. Customers have the components during the push phase. The opportunities
convenience of ordering anytime and anywhere, while are most significant for new, hard to forecast products,
Dell may track all corporate-wide purchases. As such, it where aggregation offers the greatest benefit in terms of
becomes a virtual IT department in addition to just being inventory reduction. Nevertheless, self-reliant ordering
a corporation's PC vendor. Finally, by tracking and assumes a somewhat experienced customer who requires
managing cash flow very tightly, a negative cash- less handholding. As such, the e-channel may
conversion cycle of a few weeks is gained: Dell gets paid complement the strength of existing retail channels with
before it pays its supplier, exploiting direct payment with focus on service and educating consumers to choose low
postponed delivery. Increased response time is perhaps cost computers.
the only negative revenue potential that Dell has
compared to traditional brick-and-mortar retailers. Customer Customer
On the cost side, the direct model eliminates Pull Pull
intermediaries. In addition, long-term relationship with
Supermarket
high-reliability suppliers such as Sony allow Dell to ship Peapod
monitors directly from the supplier to the customer, Fulfillment Center
eliminating costly warehousing costs and the delays in Warehouse (?)
additional inventories. Not only are warehousing
decreased, ordering personnel costs are transferred onto Suppliers Suppliers
the customer!
The greatest inventory benefits accrue from a Peapod Supply Chain Supermarket Supply Chain
fast, well-coordinated supply chain that enables the Figure 5: Peapod and a typical supermarket supply chain
separation of procurement cycle from customer order and
manufacturing cycle. While procurement is initiated in B2C in the Grocery Industry: Peapod.com
anticipation of demand, manufacturing and fulfillment is
only started when an order arrives. This is possible by Peapod.com is one of the oldest online grocers. The
adopting common platforms and components for various company started in Chicago in a collaborative
products. While finished goods inventory is eliminated arrangement with the supermarket chain Jewel where
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e-business and the supply chain
Peapod’s pickers would fill an order before delivering it. centralization are marginal because supermarkets already
Peapod has now moved to supplying orders from achieve sufficient forecast accuracy thanks to their large
centralized fulfillment centers in areas that the company size. (If, however, online grocers focused primarily on
serves. Each fulfillment center is much larger than a specialty items, as EthnicGrocer.com, inventory benefits
supermarket and is comparable to a warehouse. The from aggregation would be larger.) Online grocers incur
Peapod and supermarket supply chains are comparable significantly higher transportation costs than a
except that some supermarket products are supplied supermarket because of home delivery. Indeed, groceries
directly from suppliers (Fig. 5). have a low value to weight or volume ratio. They require
On-line grocers allow order placement anytime a specialized delivery fleet whose cost will necessarily be
and from anywhere. They can attract customers who do rather high as a fraction of the value. This precludes
not like to go to a supermarket (who does?). They have centralization on a large national or even regional scale;
flexibility on pricing and promotions. They could indeed, most e-grocers have warehouses in each
provide a large variety of goods, including specialty metropolitan area that they serve. In addition, depositing
items, such as ethnic foods, although Peapod does not the groceries at the customer is much less flexible than
offer significantly more variety than a typical putting a book in the mailbox: with fresh goods,
supermarket. In addition, they can bundle menus and consumers need to be home to take delivery, which
recommended ingredients with specialty items, based on creates significant peak demands early morning and after
tracked online shopping behavior and histories. Unlike a 5pm. Finally, while delivery density in cities may be
supermarket store, which has no knowledge of what has sufficiently high, achieving an acceptable number of
been purchased until a customer checks out or of the delivery stops per hour in a spread-out suburban area will
substitution patterns for goods that were stocked out, be difficult. (Many e-grocers strive for gaining market
Peapod can guide online shopping behavior with real- share to improve delivery density and may extend into
time suggestions. Peapod can use its data for targeted general home delivery of other goods. Yet it is
interactive advertising and discounts. This revenue boost questionable that even such strategy can ever compete
is significant to the extent that most e-grocers at this with parcel companies like UPS or FedEx, who not only
stage have lost money in the actual sale of groceries but deliver, but also pick up; resulting in double efficiencies.)
made money on the sale of consumer choice data to This scorecard analysis, summarized in Figure
suppliers. On the cost side, the virtual store reduces 6, suggests that e-grocers have negligible opportunity to
facility costs by eliminating retail sites and checkout compete on cost in general grocery items, especially fresh
clerks. Inventories are reduced due to centralization; food. Indeed, all key conditions listed earlier to exploit
although savings would accrue primarily to slow moving, cost benefits are violated. Competition, therefore, must
specialty items. be on convenience or some other form of value added.
E-grocers also have several disadvantages For example, opportunities do exist for specialty or
compared to their brick-and-mortar counterparts: ethnic segments. Also, convenience can be added by
increased response times and additional outbound automating the repeat purchasing activities that most
transportation costs to cover the last mile to the customer. households go through each week. Once a weekly basket
W argue that e-grocers have a negligible opportunity to is set up on the web, repetitive ordering is greatly sped
compete on cost, except perhaps for specialized low- up. In addition, the supply chain may exploit recurrent
volume, dry items. The e-grocer incurs additional patterns by smoothing and leveling the load provided a
activities in picking, packing and handling that are not solution is found for the delivery so that customer
incurred by a traditional supermarket where customers do presence is not needed. (Competitor Streamline.com
pick and pack; and handling is done in high volume allows unattended delivery by installing fridge and
(pallet based). The inventory savings due to
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e-business and the supply chain
storage boxes with keypad access system at their over the entire supply chain can be improved as customer
customers.) orders automatically trigger supply orders when
The greatest opportunity of an e-channel, inventories need replenishment. Inventory and facility
however, may be for incumbent supermarket chains, costs at Grainger will not change significantly by going
which already own the regional distribution centers. online unless it decides to close some of its branches.
They can set up the additional e-channel as a focused Online sales by Grainger also offer a significant
"plant-within-a-plant" to expand the value offering. In cost reduction opportunity for buyers. Ordering costs
addition to picking themselves, customers could choose drop significantly and buyers can allow end users to
to have supermarket personnel pick the order from the order directly, improving response time and decreasing
shelf but the customer provides outbound transport, or, errors.
the supermarket could provide home delivery at the The sale of MRO supplies is an example where
highest price. Among supermarket chains, Albertson’s the Internet is ideally suited to eliminating the
has taken the lead at combining e-business with weaknesses of the current system. The basic supply
traditional supermarkets. Part of the store is a fulfillment chain remains unchanged but going online allows both
center for online orders, while the other part is a buyers and sellers to decrease the transaction cost of
supermarket. This allows the firm economies of scale on placing and fulfilling orders and increase the product
inbound transport while keeping delivery distances to portfolio. The use of the Internet to replace existing
customers short on outbound. Our analysis would channels of order placement is likely to grow at a
suggest that such dual-pronged approach is the most significant pace in the B2B arena.
effective positioning of e-business in mass-market
groceries where pure online grocers are likely to be less B2B Auctions in Procurement: Internet Exchanges
effective.
Internet exchanges create electronic markets and
B2B in the Parts Supply Industry: W.W. Grainger communities where firms can obtain information and buy
and sell products. Not only do they act as on-line
W.W. Grainger is a business-to-business distributor of auctioneer, they may also inspect and 'approve' (certify)
maintenance, repairs and operating (MRO) supplies, bidders or suppliers along various non-price factors.
ranging from consumables like machine lubricants to At first glance, the greatest benefit of an
hardware items like nuts and bolts for repairs. Grainger Internet exchange is to buyers who have the ability to
is famous for their 4-inch thick catalogs with thousands search across multiple suppliers when looking to procure
of parts that customers could order over the phone or buy an item. By substantially lowering barriers to entry in the
at one of the 380 branches in the U.S., which are similar bidding process, Internet auctions drive down supply
to a large retail store. In 1995, it set up Grainger.com, prices. Lower prices are the cost of wider demand
allowing customers to place orders on its website that markets to suppliers. This seems to imply that all buyers
offers over 200,000 products. of commodity products may benefit from purchasing at
Going on-line provides considerable revenue auction exchanges. There are, however, considerable
opportunities: 24-hour access for order placement with a downsides to this approach if it is implemented
very large selection available through easy electronic indiscriminately. Purchase of all products using auctions
search. Product information is updated easily, allowing may lower the purchase price but will tend to increase the
price and promotion flexibility. New products can be total cost of purchase for a firm. The ability to lower
added to the "virtual catalog" immediately, drastically supply chain costs requires long-term relationships
improving time to market. Allowing industrial customers within the supply chain. Indeed, the movement towards
to place order anytime is a considerable convenience for lean operations, as exemplified by Dell, heavily depends
night shifts, who no longer have to notify day purchasing on a few suppliers who become "long term partners." In
to place orders, but now can do it immediately, the auto industry, the last two decades of the twentieth
drastically reducing their response time. Not only can century focused on improving supply chain relationships
delivery times be estimated for each order using up-to- so that suppliers and auto manufacturers could work
date inventory status, the customer also can be alerted closely to improve the way products were designed,
automatically (through email) regarding order status. A manufactured, and delivered. Chrysler significantly
downside of on-line ordering is increased ease of improved its performance by getting suppliers involved
comparison shopping, which is expected to drive down in the design phase of a new product. This level of
prices and margins. Yet Grainger realized that it is better supplier involvement is only possible given a long-term
to cannibalize its own brick and mortar channel than to relationship between suppliers and manufacturers.
let others do it. Thus, core products that a buyer requires in
Considerable cost opportunities exist compared significant and steady quantities should not be handled
to the phone or mail order channel: order taking costs through a bid or auction process hosted by an
reduce as the customer participates. More importantly, intermediary. Direct e-business between the buyer and
errors are greatly reduced as duplication of data entry is seller should be used in this setting to reduce transaction
eliminated. Catalog-printing costs reduce significantly. costs of order placement and fulfillment and improved
Inventory and transportation costs are marginally information exchange during order fulfillment as well as
impacted, as the fulfillment system remains largely product design. A good example of this approach is Dell
unchanged. By integrating the suppliers, synchronization and its use of e-business when dealing with its suppliers.
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e-business and the supply chain
Dell does not use the Internet to create a marketplace • Devise shipping pricing strategies that reflect the
where suppliers compete against each other for orders costs of activities. Disregarding or
from Dell. Dell uses the Internet to exchange demand underestimating transportation costs has
and inventory information with its suppliers. This allows contributed to the losses incurred by e-grocers to
suppliers to set appropriate production levels and help date.
the Dell supply chain to better match supply and demand. • Design the supply chain to efficiently handle
When it comes to utilizing excess or surplus returns. Because the Internet cannot match the
capacity (i.e., any capacity left after utilizing base traditional customer experience of touching,
capacity), the story is very different and on-line feeling, testing and even smelling the product
auctioning may provide significant opportunities. before buying it, returns in an e-business will
Exchanges provide the ability to aggregate and display all always exceed those of traditional store.
available surplus capacity across an entire industry. As • Keep customers informed throughout the
such, a market is created to better match surplus capacity fulfillment and returns cycle.
with unmet demand. For example, a manufacturer in
need of unforeseen additional transportation may place
an emergency shipment out to bid if their regular trucking M. E. Porter, "What is Strategy?" Harvard Business Review,
company has no trucks available. By matching uncertain Nov-Dec 1996.
components in demand to aggregated surplus capacity
(supply), online auction markets may improve the overall
match of demand with supply obtained from long-term
contracting. Our analysis would suggest a two-pronged
purchasing strategy: for stable, recurrent demands the
Internet focus should be on reducing transaction costs
and improving supply chain performance, while online
auctions may be used to satisfy uncertain demand where
the value of aggregation is the greatest.
Incentive problems and credibility suggest that
the auction market is best provided through an
intermediary. The key issue may be to account for the
total cost in the auction, including product,
transportation, and other relevant costs. For example, if a
seller is offering a stamping press currently in Northern
Italy, an offer from that region is more attractive that an
identical offer from Belgium if the seller incurs the
transportation cost. While incorporating such non-price
factors may be automated for more commodity products,
it is much harder for customized products.