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N o . 17 7 O c t o b e r 2 0 0 9
THE CUSTOMER VALUE PROPOSITION
SHOULD DRIVE SUPPLY CHAIN DESIGN:
1
AN EXAMPLE IN MASS RETAILING
A
typically
of these five factors can describe
starts with a deep understanding of
successful
company
the value propositions of different
customer needs in a segment and
retailers.
translates these needs into a value
proposition. Then it develops its
The best indicators of variety are the
supply chain capability to deliver on
number of product categories and the
its value proposition. Many companies
number of stock-keeping units (SKUs).
have a clear and compelling customer
Wal-Mart and Tesco, for example, offer
value proposition but fail to reap the
a wide range of product categories –
benefits because their supply chain
from food and clothing to garden Corey Billington
capabilities are inadequate and their
equipment and home electronics – IMD Professor of
supply chains are not correctly linked
to their customer value proposition.
with the value proposition promising Operations Management
a one-stop shopping experience. In
In this article, we will use examples
contrast, Trader Joe’s, a US-based
in mass retailing to illustrate the
chain of specialty grocery stores
link between value propositions and
owned by German retailer Aldi Nord,
supply chains. Fundamentally there
mainly offers a limited range of food
are two value propositions: price-
items – some of which a consumer
based and value-based. There are
may not find in regular grocery
two supply chains: flow-based and
stores. Retailers also need to decide
batch-based. We argue that aligning
how many brands or sizes to offer
the customer value proposition with
within a specific product category or
the supply chain model is critical to a
subcategory. Compared to Wal-Mart, Winter Nie
company’s competitiveness.
Aldi and Lidl offer very limited product IMD Professor of Operations
Procurement and
choices within a category. Generally,
Five key dimensions in mass retailing
for
a
given
volume,
increasing
variety creates a more complex and
In the retail business, a customer
expensive supply chain.
wants the right product, at the right
time, in the right place, and at the
In terms of product assortment, there
lowest possible price. To translate
are fixed and variable assortment
these
chain
retailers. The vast majority of items
capabilities, mass retailers should
sold by fixed assortment retailers
consider the product variety, the
are constant – customers expect
product assortment, the type of
to find them every time they shop –
brand
private
while a relatively small percentage
label), availability levels, and the cost
of items are short-lived SKUs such
of goods sold. From a supply chain
as seasonal clothing or one-time
perspective,
bundles.
needs
into
(manufacturer
various
supply
vs.
combinations
These
retailers
provide
and Service Management
THE CUSTOMER VALUE PROPOSITION SHOULD DRIVE SUPPLY CHAIN DESIGN:
standard products in standard sizes, and the
strategy, availability for a specific SKU will be
store layout is such that customers know where
compromised. The availability of a bundle of
to find the products. Variable assortment
eight Colgate jumbo sized tubes of toothpaste
retailers, by contrast, offer some standard
for $8 offered in Costco cannot be guaranteed
products, but a much higher proportion of
everyday, whereas customers can always find a
the offering is variable and changing. Even if
single tube of Colgate regular sized toothpaste
the category is constant, the SKUs within the
at the lowest price in any US Wal-Mart store. The
product category may change. Wal-Mart is an
most important implication is that a company’s
example of a fixed assortment retailer, Costco of
customer value proposition should determine
a variable assortment retailer. Fixed assortment
its supply chain choices.
supply chains are generally more expensive
If we focus on mass
retailing, essentially
there are two
fundamental customer
value propositions.
One offers the lowest
possible price with
an efficient shopping
format; the other
offers the highest
possible value with
shopping excitement.
than their variable assortment counterparts,
Value-based and price-based customer value
mainly because they have to cope with demand
propositions
uncertainty. When a variable assortment chain is
out of an item, it replaces the item with another
If we focus on mass retailing, essentially
SKU, which means it can hold less stock.
there are two fundamental customer value
propositions. One offers the lowest possible
A closely related set of issues revolves around
price with an efficient shopping format; the
manufacturer
other offers the highest possible value with
brands
versus
retailers’
own brands. The 7-Eleven chain sells a high
shopping excitement.
proportion of manufacturer brands, while Aldi
sells primarily private labels. Wal-Mart and
Everyday low price, always
Tesco have traditionally been retailers with
The well-known value proposition of Wal-
strong manufacturer brands, although recently
Mart – not only the world’s largest retailer but
they have moved more toward their own brands.
also the world’s largest company – is “everyday
Private labels mean retailers do not need to pay
low prices.” Behind this value proposition is
a manufacturer brand premium and have more
also an implicit promise of high product variety
flexibility to source at the lowest cost, perhaps
(35,000 SKUs in a typical store; 100,000 in a
by taking up a supplier’s spare capacity.
superstore), fixed assortment, a mix of branded
and private labels, and the lowest possible cost
In terms of availability, high availability means
of goods sold with extremely high availability.
that all the items are almost always in stock;
In other words, customers know that whatever
there are very few stockouts. Overall Wal-Mart
and whenever they buy, it is at a favorable
has very high product availability, while Trader
price. Shopping is predictable and efficient;
Joe’s has relatively low product availability. High
customers can buy at any time and the price
availability costs the retailer significantly more
will stay reasonably constant. They can expect
because more inventory is required to prevent
to satisfy almost all their basic needs from food
stockouts.
to clothing to home furnishings at one store.
Moreover, all the items are almost always in
The cost of goods sold includes the cost of the
stock. Once or twice a year, Wal-Mart brings
items themselves plus other supply chain costs,
one-time special deals to the market, which are
such as inventory, warehousing, logistics and
communicated to customers as such, and there
the like. Naturally the effectiveness of sourcing
is no rain check for them.
impacts the cost of individual items.
The move toward more private label brands
These five dimensions are not independent of
at Wal-Mart is consistent with the company’s
one another. The choice a retailer makes in one
evolving value proposition. In the early days,
implicitly determines or limits the choices it can
it was everyday low prices on manufacturer
make in another. Thus, without increasing costs,
brands that brought people into the stores. But
if the retailer chooses a variable assortment
now, the Wal-Mart brand itself is more powerful,
AN EX AMPLE IN MASS RETAILING
with great drawing power – to get people into the
store’s loyalists include an eclectic assortment
stores. And – once there – they are finding Wal-
of foodies, college students, sugar fiends and
Mart products next to brand name products,
health nuts.
where the only difference seems to be the price.
This allows Wal-Mart to sell its own brands at
Another fundamental difference between price-
higher margins than manufacturer brands.
based and value-based retailers is that much of
what is purchased is discretionary in the value-
To support the value proposition of low price/
based segment. The customer rarely needs
guaranteed availability of regular items, Wal-
these items immediately – larger quantities
Mart uses a very efficient supply chain. Its
are often purchased (e.g. eight tubes of
approach to suppliers is generally one of hard-
toothpaste not one). A related issue is the share
nosed negotiation, where prices are continually
of disposable income, or the extent to which
squeezed, the suppliers are held to ever-tighter
these retailers keep customers from buying
measures of delivery performance, and supply
elsewhere. When someone buys eight tubes of
chains are optimized using highly detailed real-
toothpaste, it will be a long time before more
time information and the latest technology.
is purchased – anywhere. Similarly, if someone
To a large extent, the innovations are focused
buys Alaska king crab legs at Costco, there will
on “doing the same things better,” in that the
be one less trip to the local fish market, but
emphasis is on optimization and cost reduction
the customer might be more likely to return to
in the supply chain.
Costco in the near future to see if the same, or
a similar, deal is available.
We shop the world for you
Trader Joe’s has locations in most of the larger
To support a value proposition of exciting
population states in the US. Behind its slogan
shopping value, the procurement organization
“We shop the world for you” is the implicit
for variable assortment retailing needs to find
promise of relatively few product categories, a
and deliver the “treasures.” Trader Joe’s aims to
variable assortment, a high proportion of private
carry only products that it can buy and sell at
labels, and the best value with relatively low SKU
an outstanding price, even if it means that the
availability. Both Costco and Trader Joe’s add to
items change from week to week. This means
the shopping experience by giving the customer
the company must interact with a larger set of
a sense of finding something unexpected at
suppliers, sometimes even for a one-off deal.
excellent prices. For example, the wine “Two-
The quantity is also different each time. Rather
Buck Chuck” sold by Trader Joe’s tends to be
than making routine purchases over some time
fairly good wine, of which the manufacturer
to replenish stock, the retailer often buys all
has an excess supply, but does not wish to
that the supplier has for sale – in one batch. In
reduce the perception of the brand by flooding
turn, this merchandise is put into the stores for
the market with it. A key element of the value
as long as it takes to sell it.
proposition is “treasure hunting.” Customers are
never quite sure what variable assortment items
Varied assortment retailers like Costco, Aldi
will be available. Further, the “treasures” are in
and Trader Joe’s do also sell standard items
limited supply – if a customer sees something
such as bread and milk, which require supply
she wants, she must buy it now.
chain processes similar to those used by fixed
assortment companies such as Wal-Mart. One
This value proposition appeals to some customer
of the major differences might be a willingness
segments that are different from those served
to tolerate somewhat higher probabilities of
by Wal-Mart. For example, the family income
stockout. After all, customers do not expect to
of Costco shoppers is more than double that of
find every item every time. The interaction with
2
Wal-Mart’s. Customers at Trader Joe’s can be
a supplier like Colgate might be fairly standard
characterized as having a spirit of adventure
for some special package (e.g. eight tubes
and being inclined to try new products. The
of toothpaste), but the interaction might also
To support a value
proposition of exciting
shopping value,
the procurement
organization for
variable assortment
retailing needs to
find and deliver the
“treasures.”
include opportunistic buying: What do you have
The batch-oriented supply chain is most
that you would like to sell at a good deal (we will
appropriate for situations where the source of
buy it all)?
supply changes rapidly – with no predictable
timing – because the retailer is pursuing good
Store replenishment at Trader Joe’s is quite
deals and providing a variable assortment. For
different than at Wal-Mart. For variable SKUs,
such retailers, like Costco and Trader Joe’s,
there is little “reordering,” since items change
each good deal needs to be individually priced,
all the time. At the store level, Wal-Mart is
contracted, and its logistics details determined.
executing its plan as efficiently as possible,
Instead of a continuing series of shipments,
while Trader Joe’s is responding to discovered
there is one batch, which either needs to be
opportunities in the most attractive way.
delivered to the retailer’s distribution center or
else distributed directly from the supplier to the
Different customer value propositions require
individual retail outlets.
different supply chains
Compared with the flow-oriented supply chain,
There are two fundamental approaches to
there is no expectation of long-run retail support
supply chain design: flow-oriented or batch
(or end customer provision) of this item. Instead
oriented, although in practice there is not a
the focus will be on the overall contribution
clear demarcation and most firms will have a
of this SKU, the cash-to-cash cycle, and the
combination of the two.
extent to which this “deal” builds store traffic.
In terms of procurement, there will be a greater
The classic, or flow-oriented, supply chain such
need for prospecting to find the “treasures.” In
as that at Wal-Mart is set up on the premise
a batch-oriented supply chain the price of the
of a relatively fixed series of recurring
goods is the focus, with less attention on SKU
transactions, shipments, payments, and other
availability. The variable assortment retailers in
conditions. It is typically evaluated with standard
essence provide a risk service to the suppliers,
metrics such as OTIFNE (on time, in full, no
allowing them to sell rather than scrap excess
errors), inventory turns (for both the customer
capacity and excess inventory.
and the supplier), speed, quality issues, and
responsiveness to unusual situations, e.g.
As we have seen, the supply chain requirements
promotions.
to support the price-based value proposition
the value-based proposition (batch-oriented).
chain
capacities,
To attract customers, mass retailers have to be
largely because it needs to ensure variety
tends
to
strain
factory
clear about their value propositions. To deliver
and availability. Many of the costs are hidden,
what they promise, they must align their supply
imbedded in the operating structures of the
chains accordingly – something that the stores
suppliers, but they are real.
discussed here have done very effectively.
1 In memory of our colleague Tom Vollmann.
2 Cascio, Wayne F. “Decency Means More than ‘Always Low
Prices’: A Comparison of Costco to Wal-Mart’s Sam’s
Club.” The Academy of Management Perspectives, Vol. 20,
Iss. 3, August 2006: 26.
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(flow-oriented) are very different from those for
As already noted, the flow-oriented supply