Channel Partnerships Streamline Distribution

Interactions between retailers and their suppliers have often been adversarial, with each trying to gain at the expense of the other. But this long-established pattern is rapidly giving way to cooperation, with both sides working together to streamline the distribution channel system. Examples of channel partnerships cover the full spectrum of contemporary retailing. Perhaps most often cited is Wal-Mart and Procter & Gamble’s partnership, initiated in 1985. Lou Pritchard, then sales vice president of P&G, has recounted how he and the late Sam Walton developed the concept of a partnership “built on trust and committed to a shared vision — meeting the customer’s needs while driving out excess costs in the system by changing it.”1 Aided by new information technologies such as electronic data interchange (EDI), the two companies dramatically improved the efficiency of their product flows: P&G’s on-time deliveries to Wal-Mart improved significantly, while inventory turnover increased dramatically. Kmart and other discounters were quick to establish their own partnerships, followed by conventional department stores (such as Mercantile Stores) and specialty chains.

More recently, channel partnerships have become popular in the apparel industry. VF Corporation, Levi Strauss, and other leading manufacturers have formed “quick response” partnerships with both discounters and department stores. By early 1993, VF had some 300 partners in its flow replenishment system and promoted the partnership idea with advertisements in trade publications.

Channel partnerships have been hailed as the embodiment of a new philosophy for buyer-seller relations — one that can be applied well beyond the consumer products marketing arena. The concept uses modern information and communications technologies to lower costs and improve service to the customer. The customer can be a nurse obtaining supplies in a hospital, a factory worker being supplied with a component, or a consumer buying apparel in a department store. A CSC Index Group report on channel partnership, for instance, cites examples of successful partnerships in hospital supply distribution, in marketing of pharmaceuticals to veterinarians, and in retailing.2

In this article, we focus on partnerships between retailers and their suppliers, which are spreading quickly and have potentially enormous impact on marketing efficiency. We address the following questions:

• What are the key features of channel partnerships, and how do they differ from other relationships between retailers and suppliers?
• What kinds of retailers and suppliers are involved in channel partnerships, and how broadly can the partnership approach be applied?

• What explains the partnerships’ rapid formation during the late 1980s and early 1990s?
• What changes must occur in traditional merchandising and distribution systems to create benefits from channel partnerships?
• How do partnerships affect business performance? What are appropriate performance measures for each party?
• What are the requirements for success in forming and maintaining partnerships over time?

Our analysis is based on interviews with retailers and manufacturers that are utilizing partnerships and with consultants in the field, as well as on published accounts and presentations at industry and academic conferences.

What Is a Channel Partnership?

While the term “channel partnership” has been used to designate a variety of relationships between buyers and sellers, we define it as an ongoing relationship between a retailer and an independent supplier in which the parties agree on objectives, policies, and procedures for ordering and physical distribution of the supplier’s products. Some partnerships also include agreements for packing, price marking, new product development and testing, and/or joint sales promotion activities, but the primary focus is almost always on ordering and physical distribution. Thus channel partnerships might also be called “supply partnerships.”

Our definition of a channel partnership is similar to Johnston and Lawrence’s definition of a “value-adding partnership,” which they characterized as “a set of independent companies that work closely together to manage the flow of goods and services along the entire value-added chain.”3 Channel partnerships that involve only retailers and producers of finished goods do not encompass the entire value-added chain, but some partnerships also include upstream suppliers of semifinished materials or components. Hammond points out that “quick response” capabilities at the point of contact with the end user depend on the capabilities of the business units at all stages of a channel or “global value chain.”4 For this reason, fabric producers have actively promoted partnerships in which they join with their immediate customers (apparel manufacturers) and retailers to improve the overall flow of goods and information.

When a retailer and a supplier agree to work as partners, there is a dramatic change in the way they deal with each other, as Richard Bravmen of Symbol Technologies described at a Quick Response Conference:

Traditionally, the relationship between retailers and suppliers (and between those suppliers and their further upstream sources) was, at best, arm’s length, if not at times downright adversarial. . . . The manufacturer’s objective was to move the greatest possible volume of goods at the highest price. The retailer’s goal was to negotiate the lowest price for those goods. . . . [Competitive] pressures led to the development of a new paradigm. It focused on a simple idea: make sure the right product at the right price is on the shelf when the customer enters the store, while maintaining the lowest possible inventory at all points in the pipeline running from suppliers to retailer. . . . Since this strategy has to do with managing the pipeline of merchandise flow, it requires cooperation between retailers and their upstream suppliers.5

One way to coordinate merchandise flows through a channel is with vertical integration — i.e., by bringing most or all stages in the channel under common ownership and control. Some retail chains such as The Limited, whose wholly owned subsidiary Mast Industries serves as its primary supply source, use this approach. Channel partnerships seek to achieve some of the efficiencies of vertically integrated systems without common ownership.

In some ways, channel partnerships are similar to franchise systems, as in the auto industry, and exclusive distribution networks, such as Benetton’s. But, while the latter systems are based on exclusive supply agreements, channel partnerships are usually nonexclusive. One exception is Levi Strauss’s relationship with Designs Exclusively Levi Strauss & Company, a specialty chain that carries only Levi’s products. For most retailers, it is essential to work with multiple suppliers because no one producer can supply all the lines the retailer carries. Even within a single merchandise category, most retailers need, or at least prefer, to have the flexibility that comes with using two or more suppliers.

Growth of Channel Partnerships

The basis of a cooperative relationship between a retailer and a supplier is not new; there have been partnerships in various forms for many years:

• Service merchandisers (“rack jobbers”) that manage and service an assigned department or category such as periodicals, greeting cards, or recorded music. Department stores, discount department stores, drugstores, and so on use this approach.
• Leased departments, such as shoes or jewelry, in which an independent contractor manages a department for a department store or discounter.

These partnerships differ from the channel partnerships that began to emerge in the late 1980s in that a single supplier is responsible for managing a product category. Contemporary channel partnerships, as noted earlier, are almost always nonexclusive.

The recent emergence and rapid adoption of the partnership concept has been made possible by the increasing availability, reliability, and declining cost of digital information/communication technologies. The critical technologies for implementing channel partnerships include bar coding, scanning at the point of sale and elsewhere, EDI, and database management. Other technological elements include radio frequency (RF) transmission for remote access to databases, digital imaging, and video conferencing.

The establishment of industry standards for product identification and data interchange have also facilitated partnerships. Standards in the apparel industry developed after fabric and apparel manufacturers and retailers demonstrated potential partnering benefits in tests during 1986 to 1988. Without industry standards, companies seeking to cooperate with their suppliers and/or customers would be confronted by a babel of incompatible, proprietary systems and procedures that would make the whole idea extremely costly, if not impossible.

While adequate technology coupled with industry standards are necessary conditions for effective channel partnerships, they are insufficient for their acceptance. Supermarket chains, food wholesalers, and their suppliers adopted bar coding, scanning, and EDI based on industry standards several years earlier than in the apparel industry. But there were few channel partnerships in the food distribution system as of late 1994. Apparently managers need other incentives to convince them of the necessity for partnerships.

In the apparel industry, one factor motivating retailers and suppliers to change their operations has been the rapid growth of vertically integrated specialty store chains. The most successful of the specialty chains, The Limited, relies almost entirely on private-label merchandise from offshore contract suppliers. The entire system is centrally managed, based on point-of-sale (POS) data captured in each store for each stockkeeping unit (SKU). This system has enabled The Limited to replenish store inventories of fast-selling items rapidly while reducing prices on slow movers early in the season. As a result of this and other competitive advantages, the company has gained market share at the expense of department stores and traditional specialty stores; they, in turn, have been stimulated to try partnering to achieve at least some of the efficiencies of integrated systems. (Perhaps partly as a result, department stores appeared to regain some lost market share in the early 1990s.)

Related to the competitive success of integrated retailers is the growth of apparel imports to about 50 percent of U.S. consumption. In 1984, in an effort to stem the import tide, domestic textile and apparel producers formed an association called “Crafted With Pride in the U.S.A. Council” (CWP).6 Initially, CWP attempted to influence consumers to buy domestic products through an advertising campaign and product labels. Later, CWP shifted its focus to providing superior service to retailers, based on the advantages of local domestic production. This was the starting point for the “quick response” (QR) movement, which became, to some degree, self-reinforcing as industry executives, consultants, and publications vied with each other to “preach the gospel” of quick response.7

For some retailers, an important impetus to partnering has been the growing competition among different retail formats. Warehouse clubs and deep-discount drugstores enjoyed rapid growth during the 1980s, creating strong competitive pressures for established retailers, especially conventional supermarkets. In response to these pressures, the major food industry trade associations commissioned a study showing the potential efficiency gains that could be achieved by “efficient consumer response,” in which distributors and suppliers would work together “to bring better value to the grocery consumer.”8

A final factor that stimulated interest in channel partnerships has been the growth of just-in-time delivery systems in automotive and other industries. Spurred by the success of their Japanese competitors, U.S. auto producers and their independent suppliers have achieved significant economies by designing systems to replenish component inventories automatically. These systems are functionally very similar to the ones used for finished goods in retail stores.

By mid-1993, many different types of retailers and suppliers had formed numerous channel partnerships (see Table 1 for examples of the partnerships’ diversity). While most partnerships have dealt with ordering and distributing basic products with relatively long life cycles, The Limited’s experience indicates that the approach can also be used, with some modifications, for fashion apparel. While only large companies are listed in Table 1, some small firms, such as Warren Featherbone, a producer of children’s clothing with annual sales of about $20 million, have successfully implemented partnerships.9

Streamlined Merchandising and Distribution Processes

Bar coding, scanning, EDI, and other digital technologies can improve efficiency and effectiveness in one of two ways: by automating existing processes or by reengineering them. The distinctive advantage of channel partnerships is that they allow more fundamental modifications in merchandising and distribution processes than suppliers or retailers could achieve if they continued to act independently. For this reason, we believe that successful channel partnerships will be based on a joint approach to reengineering rather than simply automating traditional procedures. As a food industry study of efficient consumer response (ECR) pointed out, “Automating inefficient business processes is both complex and ineffective. ECR focuses first on reengineering business processes to make them efficient, then automating them, at much lower cost, to further reduce wasted time and cost.”10

A logical starting point for process improvement is to document the existing steps. In this section, we describe the typical stages in the traditional (prepartnership) merchandising and distribution processes that retailers and suppliers, independent of each other, employ. In the following section, we explore how partnerships are reengineering the processes to be more effective and efficient.

The main steps involved in conventional merchandising and distribution processes are outlined in Figure 1. The specific process components and ways to implement them vary among different retailers and products: new product development for fashion apparel, for example, differs dramatically from that for food or household products. But the process overview in Figure 1 is a useful general framework for analyzing the improvement opportunities channel partnerships offer.

1. Assortment Planning.

The process begins when the retailer plans an assortment for a particular product category. It makes decisions on how broad the assortment of styles, colors, brands, and other product variations will be; how much shelf or floor space to devote to the category and how to allocate space among suppliers’ lines and product types; how much inventory to carry; and what type of fixtures to use. The retailer may reconsider these and related strategic questions infrequently or every season.

Traditionally, a supplier’s only involvement in assortment planning has been to try to gain more space or a greater share of the retailer’s inventory investment through personal selling efforts and trade promotion and, sometimes, by providing display fixtures.

2. New Product Development.

Manufacturers develop and test new products and offer them to retailers, which place initial orders for some of the products (Figure 1, box 2). Developing new products may occur on a regular, seasonal cycle, as in the apparel industry, or may be sporadic.

Traditionally, the manufacturer has done most new product development, including concept development, design, and testing before any presentation to retailers. Fashion apparel producers, for example, typically develop an extended assortment and show it to retail buyers at the seasonal fashion shows. Before the shows, the fabric and style selection is based on designer intuition. The initial assortment is “edited” after buyers make their first selections, based on their own intuition. This process leaves little or no room for systematic consumer testing of new styles or fabrics.

Once retailers place their initial orders, suppliers process the orders, prepare them for shipment, ship the merchandise to distribution centers or stores, and bill the retailers. The retailers, in turn, receive and check the shipments, redistribute them to stores if necessary, and make payments. (Figure 1 omits these steps for initial orders to simplify the diagram. The same order placement and fulfillment steps are, however, shown for replenishment orders.)

3. Replenishment.

Once a retailer stocks a product, and assuming that its life expectancy is long enough to permit reordering, the next stage is to replenish retail stocks. In traditional systems, the retailer has been responsible for most or all resupply tasks, including recording sales, returns, and merchandise transfers, calculating and/or checking inventory, forecasting future needs, checking proposed purchases against financial limits (“open to buy” control), and placing orders. The retailer usually transmits orders by telephone, mail, or, more recently, fax. The supplier’s role in replenishment is to influence buying decisions through selling efforts and promotion; in some cases, suppliers have helped retailers in manual inventory checking.

Traditionally, whether a product could be reordered at all has depended not only on the expected duration of consumer demand but also on the time required to fill retailers’ orders. Often, even products with relatively long life expectancies — up to six months— cannot be reordered within a season, with the result that popular styles and colors are frequently out of stock.

4. Order Processing.

When an order is placed, the supplier responds with a series of order processing and shipment steps. This process includes receiving the purchase order and entering it in an order processing system, checking credit, assembling the order, packing, invoicing, and arranging to ship, typically via common carrier. In most cases, replenishment orders are filled from the supplier’s finished-goods stock. In the apparel industry, many orders are shipped incomplete or even with substitutions of one item for another.

Shipments to a retailer’s distribution center or stores are usually handled by the lowest-cost common carrier, with no concern for reducing transit time. And there is little or no opportunity for tracking shipments.

5. Inventory Control, Forecasting, and Production Scheduling.

As orders are shipped, the supplier enters them into an inventory control system (box 5). The supplier then uses the information about shipments and inventory, along with current assessments of market conditions, to forecast sales and schedule production and purchases accordingly. In traditional systems, the supplier relies primarily on analysis of its own shipment data, perhaps supplemented with field sales personnel’s information about retail sales trends. As a result, the supplier usually has an imperfect picture of consumer trends.

6. Receipt and Distribution.

The retailer’s distribution center (in some cases, the stores) receives incoming orders from suppliers and redistributes them to individual stores. The retailer checks the shipment against the supplier’s invoice and the original purchase order, records any discrepancies, and inspects the merchandise for defects. Often, incoming merchandise must be ticketed and otherwise made “floor ready” (put on hangers, and so on).

If the shipment is received at a distribution center, it may be allocated to individual stores or added to reserve stock after arrival (postdistribution). Alternatively, the shipment may arrive in batches that have already been assigned to stores. Such predistributed shipments are transferred as quickly as possible to the stores to minimize delays. In the apparel industry, typical lead times between order placement and receipt have been thirty to sixty days; this means that, for predistributed shipments, item quantities for each store have been determined long before the date on which the merchandise actually arrives at the store. Once received, incoming merchandise may be checked again and displayed.

7. Store Selling Tasks.

When the merchandise is finally on sale in the store, the retailer provides information and advice to customers and maintains displays. Sales personnel are usually responsible for calculating markdowns at the register or manually marking the merchandise. Any merchandise returns are usually recorded manually as well. Sales personnel also observe trends and report them to department managers and/or buyers.

Reengineered Processes

A primary goal of channel partnerships is to reengineer processes to decrease the total system cost, shorten the time to replenish inventories, and reduce the amount of inventory carried in a channel. Ideally, a task force including both retailer and supplier representatives redesigns a merchandising and distribution process. Improvements in the process may include:

• Using information technology to automate manual activities, as when point-of-sale scanning, rather than manual stock counting, is used for measuring sales.
• Eliminating redundancies, such as order entry by both supplier and retailer.
• Reassigning tasks for maximum systemwide efficiency, such as moving the task of ticketing merchandise to the supplier, which makes it “floor ready.”
• Reducing or eliminating control steps in the process by capturing data more accurately and developing greater trust between partners.

Few, if any, partnerships have evolved to the point where they include all the process changes we describe. In fact, most currently focus on replenishment, order processing, and receiving and distribution. We therefore begin by discussing how automatic replenishment has changed these elements of the process.11 The basic steps in automatic replenishment are outlined in Figure 2.

· Replenishment.

Ordering basic merchandise begins with the electronic capture of sales information at the point of sale (shown in Figure 2, box 2) by using UPC-coded price tickets and scanning technology to update inventory records instantaneously. Periodically, the amount of inventory of each SKU is compared with the amount specified in the “model stock” that the supplier and the retailer jointly develop for each store. The model stock for an item is usually based on its recent sales history, modified to account for anticipated promotional activities and market trends. More advanced systems combine dynamic modeling of sales trends with managers’ judgment to allow for continuous revision of stock levels, thereby tying orders even more closely to unfolding market demand.

The model stock quantity for an SKU is set at a level sufficient to cover expected demand, with a prespecified probability, between the placement of an order and its arrival at the store.12 Often the model stock quantity is determined to provide a 95 percent “service level” (probability of being in stock) for each SKU. A major benefit of the partnership approach to the retailer is that well-designed model stocks yield significantly higher rates of inventory turnover than traditional merchandising methods. For example, in the flow replenishment system at Vanity Fair Mills, department store model stocks of intimate apparel are designed to produce an annual turnover rate of four, about twice as rapid as the recent average for this type of store.

In principle, POS data can be used to generate replenishment orders whenever the inventory of any SKU falls below a prespecified level. In practice, most partnerships call for orders to be placed at fixed intervals such as every week or every two weeks. In some cases, POS data are sent directly from each store to the supplier; alternatively, the POS data may be aggregated for all the stores served by a retailer distribution center.

As shown in boxes 3a and 3b in Figure 2, replenishment orders can be created in any of three ways:

• The retailer may give the supplier a blanket authorization to prepare and ship orders, following an agreed-on method, without any review of individual orders by retail buyers. This kind of “supplier-managed replenishment” is most commonly used in partnerships between discount retailers and their suppliers, such as Wal-Mart and Procter & Gamble. By eliminating order preparation tasks in the retail organization, it reduces buying costs but also requires the elimination of a traditional financial control step (“open to buy” review) for those orders covered by the blanket agreements.
• The supplier may prepare an order and communicate it to retail buyers via an electronic “reverse purchase order” that is, in effect, a recommended replenishment order. Under this system, the retail buyer reviews and approves the recommended quantities, possibly with some modifications. The buyer-review step entails some additional time, compared with the vendor-managed approach, but allows the buyer to make modifications based on information not available to the supplier, such as anticipated promotional activities by the supplier’s competitors.
• The retailer may prepare replenishment orders, utilizing in-house software and data analysis systems, and then transmit the orders via EDI to the supplier. Many retailers that prepare their own replenishment orders still transmit POS data to their supplier-partners to give the suppliers a better basis for sales forecasting and production scheduling.

· Order Processing.

Orders from retailers or the supplier are used to create warehouse order-picking documents. They are then assembled and prepared for shipment. Increasingly, apparel and other manufacturers are applying price tickets to their products and making them floor ready. These tasks are shifted from store personnel to the supplier, which can usually do them more efficiently.

A key feature of channel partnerships in apparel and some other product categories is the supplier’s commitment to quick response. This may mean, for example, a promise to ship core items five days after receiving an order. Some manufacturers, such as Vanity Fair Mills, have adopted modular manufacturing systems to achieve quick response, which requires a complete reorganization of production processes, including retraining, investment in additional equipment, and changes in compensation.13

· Receipt and Distribution.

Outgoing orders are usually packed and marked for individual stores. They may also be shipped directly to the stores, assuming that this does not lead to uneconomical, small shipments. An alternative is to ship the orders, designated and marked for each store, in a single batch to the distribution center. At the distribution center, the orders are cross-docked and shipped to the stores (together with orders from other suppliers) with minimal delays. Some retailers prefer to receive combined shipments at their distribution centers, delaying the allocation of merchandise by stores until that time. The rationale for this postdistribution approach is that it permits changes in allocating merchandise based on sales during the time between preparation of an order and its receipt, but the delay and additional merchandise handling is a matter of some dispute.

Whether shipments are made to distribution centers or directly to stores, the supplier can notify the retailer of the shipments electronically, which allows the retailer, in cooperation with the carrier, to schedule arrival and handling. Many carriers, like Federal Express, can track shipments in transit and provide revised schedule information when needed.

Scannable shipping container labels serve as the link between each carton in the shipment, the automatic shipping notice, and the original purchase order. Shipping container marking (SCM) technology has greatly improved the efficiency of receiving and store distribution tasks at the retailer’s distribution center or at the store level. On receipt of a shipment, carton labels are scanned to determine the order, the carton’s contents, and the store to which the carton should be cross-docked. With increasing trust, retailers replace complete verification of the order with statistical sampling of the vendor’s shipping accuracy. Thus, for many of the most efficient partnerships, floor-ready shipments arrive at the retailer’s distribution center, are scanned, and are then cross-docked to trucks bound for the individual stores without the containers ever being opened.

In some partnerships, retailers can pay for received shipments electronically and, in many cases, automatically, when sign-off on the shipment triggers the payment. With increasingly sophisticated automatic replenishment systems, retailer payment for inventory can occur as the stock is being sold to the consumer.

· Benefits of Reengineering.

Several field tests have shown the potential benefits of reengineered merchandising and distribution processes. Kurt Salmon Associates conducted some of the earliest tests for the Crafted With Pride in the U.S.A. Council in 1985 and 1986. The tests demonstrated that the time between the sale of an item and its replenishment in a retail store could be reduced by as much as 75 percent. Subsequent quick response projects at Dillard Department Stores, J.C. Penney, and Wal-Mart supported the Kurt Salmon tests by showing increases in sales of 20 percent to 25 percent, improvements of 30 percent in inventory turnover, and gains in in-stock performance from 70 percent or 75 percent to 95 percent or more.14

More recently, Kurt Salmon Associates has prepared a study for the Efficient Consumer Response Working Group, a consortium of grocery retailers and manufacturers interested in promoting channel partnerships in the dry grocery business.15 This study indicated that the time between production of an item and its purchase could be reduced from 104 days to 61 days with a partnership approach based on process reengineering.

The performance improvements achieved via process reengineering reflect a fundamental change in the merchandising process. In the traditional system, inventory was pushed through the channel, with consumer acceptance taking a backseat in the ordering process. Supplier salespeople, who were often on commission, loaded retailers with as much inventory as possible, often by offering promotional discounts. Buyers, focusing on gross margin percentages, were tempted by the promotional deals to buy aggressively and, in the dry grocery business, even adopted “forward buying” policies in which products were bought only when deals were available. As a result, total inventories in the food distribution channel are significantly greater than they would be if purchases were timed to meet consumer demand patterns.16 With point-of-sale purchase data as the driver, the new approach uses consumer demand to pull inventory through the channel. It thus results in less inventory held by both parties, higher in-stock rates, fewer markdowns, and ultimately greater sales to the consumer.

Extensions of Partnerships

While virtually all the channel partnerships that have formed so far are designed to improve the efficiency of order handling and shipping processes, there are other ways to cooperate that are logical extensions of retailer-supplier partnerships. These include joint new product development and testing, deeper involvement of suppliers in assortment planning, and joint promotional programs.

New Product Development

Some partnerships, after experiencing success in automatic replenishment, have turned their attention to improving new product development. Their primary goals are to speed the time to market and, thereby, improve the market acceptance of product introductions.

Integrated computer systems and computer-aided design have facilitated not only the development process but also the presentation of new products to retailers, particularly in the apparel business. Suppliers are now able to create designs on CAD systems and send them electronically to retailers without having to wait for face-to-face sales presentations. Video conferencing has also been used to facilitate this joint process.

Retailers are also getting more involved in new product testing before introduction, in either market tests or surveys in which the retailer’s customers give their opinions on potential market acceptance. This has proved particularly beneficial in the apparel business where, until recently, there has been relatively little market testing of new designs.

Assortment Planning

When a retailer and a supplier agree on a model stock for the supplier’s line, they are jointly planning a product assortment. In most partnerships, the scope of the assortment planning is limited to a single supplier’s product line and is typically based on the retailer’s recent sales history.

Innovations in assortment planning revolve around the concept of category management, in which a retailer works with one or a few suppliers to analyze and manage a given product category as a strategic business unit. They evaluate the performance of each SKU in a category on the basis of its rate of sale, gross margin, direct product costs, and space utilization. Retailers that have adopted category management develop sophisticated space-allocation models that combine store-level POS data with direct product cost information to make store-by-store assortment and display decisions on the basis of direct product profitability.

In the dry grocery business, some suppliers have lent their marketing and technical expertise to help their customers design and utilize category management systems. Kraft USA, for example, has studied categories for its retail customers to help them improve their assortments and displays. After a six-month study of a partner’s dairy case, Kraft’s recommendations for space allocation led to increased volume and reduced out-of-stocks for the retailer and better positioning and higher sales for Kraft.17

Joint Sales Promotion

A third area in which the scope of retailer-supplier partnerships might be extended is that of joint sales promotion programs. Some suppliers are exploring the potential of direct marketing programs geared to consumers’ characteristics in individual store trading areas. Direct marketing messages can, for example, be tailored to appeal to teenagers, senior citizens, or other groups heavily represented in a particular trading area. Tailored marketing communications, together with adaptation of a store’s product assortment to its customers’ needs, can enable suppliers and retailers to achieve even greater shared efficiencies.

Requirements for Successful Partnerships

There is much still to be learned about how channel partnership arrangements evolve over time. The experiences of suppliers and retailers to date provide some suggested requirements for establishing and maintaining a successful partnership.

First, technological skills and resources are necessary, including EDI, bar coding and scanning, advance shipping notices, shipping container marking, and sales forecasting. Kurt Salmon Associates explained the adoption of quick response in the general merchandise industry:

Technology was not a “silver bullet” solution to the industry’s problems. However, technology played a key role in enabling the implementation of the QR strategies by helping information and product to flow more quickly and more reliably through the system.18

A second prerequisite is top management’s full commitment. Successful partnering inevitably means major changes in the way each party operates. Top management must support the changes in systems, organizational structure, and culture. An important structural change is the adoption of interfunctional teamwork within an organization. Partnering can be very difficult if functional specialists are not accustomed to working with their counterparts in other departments and still less with specialists on the other side of the partnership. In a retail organization, for example, implementing automatic replenishment requires the joint efforts of the buying organization, information systems, distribution, and store management. A few retailers have accomplished this by adopting a category management organization structure, with the category manager as the leader of the cross-functional team. Other companies have established ad hoc task forces to design and install the procedures and facilities for a partnership and/or have established the position of director of partnership programs. Typically, the director acts as a staff coordinator in setting up and managing partnerships.

Top management must also work to change the adversarial attitudes that have traditionally characterized relations between retailer buyers and vendor salespeople. Since trust is a critical issue in building and maintaining partnerships, it is imperative to change organizational cultures on both sides and regard partners as collaborators rather than adversaries.

Related to cultural change is the issue of incentives for retail buyers and supplier salespeople. As we mentioned earlier, traditional compensation systems reward buyers for achieving high gross margins and salespeople for achieving sales volume targets. If buyers and sales-people are to act in harmony to achieve common goals, their reward systems must be made compatible. To provide incentives for the effective functioning of a partnership, companies must develop compensation systems that reward both buyers and salespeople, at least in part, on the basis of common performance measures. These might include some of the same measures used to assess overall partnership performance, as we discuss later.

Building and Managing the Partnership

In some of the most notable partnerships, including Wal-Mart and P&G, the vendor’s commitment to relocate some of its staff near the retailer has been critical to establishing and maintaining the new systems. P&G has assigned a separate team to Kmart as well. Most vendors are unwilling or unable to make this level of commitment. In many cases, it is difficult even to provide dedicated staff for the partnership. When dedicated staffing is impossible, confidentiality can become a sensitive issue on both sides.

Another issue concerns who bears the cost of cleaning out old inventory before introducing automatic replenishment. Retailers face the task of reducing their inventories through markdowns to the model stock level. In most cases, partners must negotiate who absorbs the cost of the markdowns.

Partners must also agree on who makes replenishment decisions. As noted above, the manufacturer can take full responsibility for replenishing retailer shelves, the manufacturer can suggest an order with retailer approval, or the retailer has full responsibility for ordering. The adopted approach often depends on the sales predictability in the merchandise category, the forecasting skill of each party, and the trust the retailer has in the manufacturer.

Maximizing the benefits of efficient merchandise and information flow may require both retailers and manufacturers to change prices. The success of automatic replenishment depends on the accurate sales forecasts used to develop model stocks. Promotional price reductions induce spikes and troughs in retail sales, which increase the complexity of the forecasting task. And retailers that rely on periodic promotions may hesitate to reduce their safety stocks for fear of being out of stock on a key promotional item. Manufacturers’ trade promotions are also problematic because they encourage retail buyers to load up on discounted items in excess of the ideal replenishment quantity. Given this incompatibility between promotional pricing and the efficiency goals of partnering, it is not surprising that many leaders in the partnership movement, including Wal-Mart, Dillard’s, and Procter & Gamble have everyday low pricing policies.

Measuring Performance

Measuring a partnership’s progress should be linked to the goals of lowering costs and improving service to the customer. Kurt Salmon Associates suggest a number of nonfinancial and financial measures.19 The nonfinancial measures include time-based measures that break down the time between order generation and restock; reliability measures such as POS data accuracy and order lead times; yield measures such as the proportion of merchandise sold at full price; and measures of customer satisfaction. In addition, we suggest measures of inventory levels (days of inventory) or, equivalently, inventory turnover rates, vendor shipment accuracy, and in-stock levels (percent of time an SKU is in stock). Careful benchmarking of these process measures over time energizes the partners, highlights potential problem areas, and provides a leading indicator of financial performance, which may not improve in the early phases of a partnership.

Financial measures include return on investment for a product category and direct product profit for a category and individual SKUs. These measures differ from the gross margin and net sales measures traditionally used to evaluate category and item performance. Because most retailers have yet to develop disaggregate cost data for individual products, many use gross margin return on investment to measure the progress of their partnership efforts.

Conclusion

We have described a new approach to manufacturer-retailer relationships — one that relies on trust and collaboration — to improve the flow of goods and information. This approach has been widely adopted by suppliers and retailers in the grocery, household appliances, and hardware and housewares industries, in addition to the general merchandise industry. However, there are still several issues to resolve:

1. How will partners ultimately divide the resulting benefits from their collaboration? To date, for example, retailers have enjoyed reduced inventory carrying costs. This creates a problem for the manufacturer that provides quick order fulfillment by increasing its own inventory, thus merely passing the carrying cost upstream rather than reducing it systemwide. In this situation, the manufacturer’s chief benefit has been the increased sales volume that results from the partnership. As retailers partner with multiple and competing suppliers, however, suppliers may be optimistic in assuming that increased sales will be the chief benefit from the partnership. Thus, in addition to reengineering manufacturing and upstream supplier relationships, vendors may find it ultimately necessary to renegotiate with retailers for a share in the benefits. The ideal solution is for a supplier to reengineer its own manufacturing and distribution processes to provide quick response without increasing inventories.
2. How will multiple partnerships maintain confidentiality when those partners compete with one another? Procter & Gamble has formed relationships with both Wal-Mart and Kmart by assigning separate teams for each account and relocating the teams to the account’s headquarters. Few other manufacturers have the resources to do that, and few other retailers warrant such efforts. For those unable to assign separate teams, the issue of confidentiality becomes particularly acute.
3. What will partnering’s ultimate impact be on the industry’s structure? Can smaller manufacturers and retailers compete in an arena where partnerships dominate? Some small players have partnered successfully. For example, General Electric has developed a partnership with its independent appliance dealers to help them compete with category specialists such as Circuit City. GE helps participating dealers reduce their inventory substantially by delivering direct from the warehouse to the customer within twenty-four hours of order entry into GE’s computerized system. Other small suppliers, such as Warren Featherbone, also seem to be able to partner effectively. Thus there is no reason to believe, a priori, that growth in partnering will lead to increased industry concentration. On the other hand, it seems certain that some retailers and some suppliers will be more effective than others in implementing partnerships. These firms will no doubt achieve competitive advantages and gain market share from their less proficient rivals.

How widespread will channel partnerships eventually become? Many argue that retailers and manufacturers that choose not to partner will find it nearly impossible to compete with the more efficient, effective business systems of those that do. By this logic, partnering will not necessarily provide a lasting differential competitive advantage, but it will be a prerequisite for competing in the future retail arena.