Tips for Success in a ‘Free Shipping’ Environment

Here’s a daunting statistic: The value of merchandise ordered via same-day delivery is expected to exceed $4 billion by 2018 — it was $100 million in 2014. The big reason for this jump is the grueling pace set by Amazon Prime Now, which offers two-hour delivery for consumers in 27 US markets and counting.



As new standards emerge, retailers in all categories are rapidly investing in their omnichannel supply chain capabilities to serve customers who want seamless shopping across channels as well as fast — and, increasingly, free — delivery.



Retailers are dealing with mounting complexity as they offer flexible fulfillment options, adding shipping nodes and allowing product returns in stores. They are forced to change forecasting, planning and product deployment algorithms and processes, requiring them to boost data analytics capabilities. They are enabling real-time inventory visibility across channels by funneling sales information back to internal market groups and vendors. They are pressured to improve in-stock levels while reducing inventory and transportation costs.



Meanwhile, they have to adapt physical networks for warehousing and transportation and change operations up and down the supply chain — including within their stores.



These moves massively stress budgets. Some of the largest retailers are investing as much as $2 billion to cover capital costs for new systems and capabilities, and we see many retailers of all sizes watching their operating incomes drop significantly because of increased expenses for “pick and pack” operations. These types of shipping expenses, as well as other new costs, can’t be passed on to customers. For example, home-delivery shipping prices have risen nearly 5% annually since 1997. These strains have come at a time when retailers are dealing with a host of other price pressures.



Several retailers are making steady progress meeting these challenges. However, many are struggling to stay relevant, especially as they look for payback on their investments in capital and operating expenses.



Based on our research and experience with clients, we found four basic rules for success.



1. Go back to basics: Understand your business and customer strategy

All supply chain decisions should be grounded in a well-defined business strategy that involves clearly knowing where you want to play and how to win over time. That requires knowing everything possible about your customers: their segment, how they shop, where they may switch to, how they want to receive and return their goods, and what they will pay for and why. Some customers want fast delivery; others prefer a predictable arrival time. However many still value tactile store experiences. And much of this behavior will change in the future.



2. Build supply chain capabilities that support your unique strategy

Until now, speed was not a vital factor. But today’s retailers are finding it necessary to invest in more fulfillment centers near customers’ homes or workplaces and deliver more small packages quickly to either location. That’s why Myer department stores in Australia abandoned its third-party centralized-distribution center model in favor of opening its own fulfillment centers closer to customers. Now Myer can deliver products more quickly to online shoppers and offer click-and-collect shopping.



But as retailers make such choices, copying the best of what others are doing may not work. Customer service levels need to be customized to a retailer’s competitive set and its customers’ needs, now and in the future. Two-hour delivery in Fairfield, Idaho, may not make sense if no one else offers it and customers do not expect it or want to pay for it.



If two-hour shipping is a requirement, then local ship-from points — either stores or local fulfillment centers — become prerequisites. This advantage holds even for next-day deliveries, as our research suggests that for large retailers, shipping next day from stores can offer up to 30% cost advantage, on average, over shipping next day from warehouses. It will make sense to retrofit store layouts to serve as fulfillment centers.



If time is less of an issue for customers, shipping from a more centralized distribution center usually is much more economical, although the costs can vary significantly by geography and product.



Amid these choices, companies are making trade-offs, investing to selectively match or beat competitors and counting on those investments to deliver revenue gains. For example, the majority of retailers now offers the option to order online and pick up at the store or have the item shipped from the store. These deals are supported by different supply chain decisions. The best companies take a methodical approach to adapting their supply chains for new services. For example, Dick’s Sporting Goods started with a well-sequenced rollout of its ship-from-store capability. After gaining confidence, it systematically added the choice to order online or pick up at the store, and has continued to refine its omnichannel offerings and infrastructure.



Increasing costs of omnichannel retailing, Amazon’s influence and the need to swiftly develop competitive capabilities have led some retailers to find joint venture partners or third-party intermediaries to scale up fast and preserve margins. These actions have also benefited some companies in other ways, such as improving their ability to leverage customer data.



3. Adapt your operating model

Retail supply chains now start with the consumer and work backward, all the way to the vendor. This requires much more involvement across areas that were traditionally considered separate from the supply chain, such as store management, product allocation, buying and assortment architecture.



Key strategic and operational decisions now need to be made with participation from marketing, merchandising, e-commerce, distribution, transportation, store management and IT. Some forward-looking retailers are realigning their organizations and decision processes to be more cross-functional.



4. Use technology and analytics as a critical enabler

Technology has always been integral to retail supply chains, but the omnichannel ecosystem raises technology requirements exponentially in an industry that has historically underinvested in this area.



Retailers now need different and better algorithms for forecasting demand; figuring out delivery vs. pick-up requirements; establishing stocking points (location and size), stock levels, reorder quantities and rules; and determining whether or not to price for delivery options — and if so, when. Beyond these analytical capabilities, retailers also need to track a customer’s order along the entire supply chain. But too many retailers struggle with outmoded technology, high IT investment costs and a skills deficit that puts them at a disadvantage to deep-pocketed competitors with Agile development approaches or newer players with more flexible architectures.



The path forward

Most retailers are at the beginning of this long omnichannel journey, with requirements that will evolve over the years. Companies need to plan for multiple time periods, understanding what projects they must do now and what can be put off until later — it’s a multiyear P&L and balance sheet issue. We counsel retailers to look at their investments and returns over time and to ensure that all costs and benefits are understood, baked into long-term plans and stress-tested, given competitors’ moves and market changes.



These aren’t easy decisions for retailers to make. But as the industry evolves, they