Supply Chain Management

Probably the most important new use of database marketing and the Web is in supply chain management. There are many different inputs that manufacturers need in order to make their finished products. Keeping the warehouse full of parts entails high interest payments and requires lots of space and employee management.

Now that everything in the world is bar-coded, it has been possible to introduce vendor-managed inventory. The system works as follows: A manufacturer keeps its inventory records on a computer that can be accessed by its suppliers through the Web. It works out arrangements with its suppliers so that they can use the Web to learn electronically every hour what parts have been used and which remain on the manufacturer’s shelves. The manufacturer discloses its sales plan so that the suppliers can estimate how many of which items will be needed each day. Then they can arrange just-in-time shipments to keep the inventory to an absolute minimum, but always sufficient so that the production line is never halted for lack of a part. Before the Web, some manufacturers used a system called EDI (Electronic Data Interchange), which served some of the same functions as vendor-managed inventory. EDI, however, was much more difficult to install and operate than the Web.

Using the vendor-managed system allowed Dell to hold less than 8 days’ worth of inventory at any given time. Without the system, Compaq had to maintain 3 weeks’ worth during the same period. This gave Dell a tremendous cost advantage. Intel shipped products to Dell three times a week without Dell’s having to process a single request—Intel could forecast Dell’s needs based on Dell’s sales forecasts and current stock usage.

Let’s see how a supplier might profit from using vendor-managed inventory and “forward-deployed” products for 400 of its 1000 best customers. These customers spend much more than other customers—that is why they are the best. Figure 9-6 shows what the new system might look like if you were the supplier.

Figure 9-6: Vendor-Managed Inventory

Your products will be stored in the customer’s warehouses and in your nearby warehouses, with title still remaining with you. Every time your customer takes your products from its shelves or from your warehouse, your vendor-managed inventory system will know this. Shipping will be notified if it is necessary to replenish products in inventory. Billing will be notified to bill the customer. Using this system, the following things will happen:

• The customer will save money: It no longer has to manage its warehouses, nor does it have to pay for any inventory until that inventory is actually used. This is a very large dollar saving to the customer.

• The retention rate for customers using this system will approach 100 percent. Customers’ spending on your products will also substantially increase, since, if they like the system, they may begin to shift to your company’s products instead of competitors’.

• Your costs will not increase. Of course, you have to maintain inventory at remote sites, but you were doing that anyway.

• We assume that your customers already have an inventory system that keeps track (using bar codes) of the disposition of each product in the warehouse. You can use the Web to poll this system and get hourly reports on the movement of inventory. You have to add the vendor-managed inventory software, which

  • Does the hourly polling of inventory status at each customer site

  • Automatically replenishes products when they run low and recalls products when they are not moving

  • Forecasts usage and automatically increases or decreases minimum stock quantities

  • Automatically bills the customer for products taken off the shelves

  • Provides complete reports for you and for all your customers

Table 9-8 shows what your 400 best customers will look like before you introduce vendor-managed inventory. What does VMI cost? That depends on the complexity of your operation. Let’s assume that it costs $1 million to set it up, which annualizes to $350,000 per year, as shown in Table 9-9. What could happen to the 400 best customers who adopt this system? See Table 9-10. The effect of the new system on total profit for these top 400 customers is shown in Table 9-11. The result is a profit of $2.6 million over 3 years.

Table 9-8 : Base LTV

	Year 1	Year 2	Year 3
Retention rate	75%	80%	85%
Customers	400	300	240
Annual spending	$50,000	$52,000	$64,000
Revenue	$20,000,000	$15,600,000	$15,360,000
Costs	70%	68%	67%
Operating costs	$14,000,000	$10,608,000	$10,291,200
Acquisition cost ($400)	$ 160,000
Marketing cost ($50)	$ 20,000	$ 15,000 $	12,000
Web site costs	$ 270,000 $ 270,000 $	270,000
Total costs	$14,450,000	$10,893,000	$10,573,200
Profit	$5,550,000	$4,707,000	$4,786,800
Discount rate	1.10	1.19	1.28
NPV of profit	$5,045,455	$3,955,462	$3,739,688
Cumulative NPV of profit	$5,045,455	$9,000,917	$12,740,604
Lifetime value	$12,613.64	$22,502.29	$31,851.51

Table 9-9 : Annual Costs of VMI Software

Software development	$1,000,000
Annualized	$350,000

Table 9-10 : Improved LTV

	Year 1	Year 2	Year 3
Retention rate	90%	93%	96%
Customers	400	360	335
Annual spending	$54,000	$56,000	$68,000
Revenue	$21,600,000	$20,160,000	$22,766,400
Costs	70%	68%	67%
Operating costs	$15,120,000	$13,708,800	$15,253,488
Acquisition cost ($400)	$ 160,000
Marketing cost ($50)	$ 20,000	$18,000	$16,740
Web site costs	$ 270,000	$ 270,000	$270,000
VMI costs	$ 350,000	$ 350,000	$350,000
Total costs	$15,920,000	$14,346,800	$15,890,228
Profit	$5,680,000	$5,813,200	$6,876,172
Discount rate	1.10	1.19	1.28
NPV of profit	$5,163,636	$4,885,042	$5,372,009
Cumulative NPV of profit	$5,163,636	$10,048,678	$15,420,688
Lifetime value	$12,909.09	$25,121.70	$38,551.72

Table 9-11 : Profit Gain with New System

	Year 1	Year 2	Year 3
LTV after	$12,909.09	$25,121.70	$38,551.72
LTV before	$12,613.64	$22,502.29	$31,851.51
Increase	$ 295.45	$ 2,619.40	$ 6,700.21
With 400 customers	$ 118,182	$1,047,762	$2,680,084

Do these numbers prove that Web pages for your best customers and vendor-managed inventory for your very best customers will work in your case? Of course not. You will have to work out the numbers for yourself. What this chapter shows you is how to go about it. Develop tables like these for yourself to see if these systems will work. Then, if the numbers look good, go ahead and see if you can

• Find the software you need at a price that will make the numbers profitable.

• Sell your best customers on adopting such a system. This will be the most difficult part of the job.