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 / Spring 2006 / Issue 42(originally published by Booz & Company)


The Hidden Costs of Clicks

Future growth in e-commerce will likely come from continued modification of existing supply chains rather than wholesale replacement. For example, despite the generally low level of Internet sales in furniture and housewares, Williams-Sonoma has achieved great success online. The company, which operates a mix of retail, catalog, and Internet channels under its eponymous store brand as well as the Pottery Barn and Hold Everything brands (among others), sold $3.1 billion in fiscal 2005 — 52 percent through its traditional retail stores and 48 percent through its two direct-to-consumer channels. At $3.3 million in annual sales for its average kitchenware store, Williams-Sonoma doesn’t gain any significant transportation economies in shipping to its stores rather than directly to its customers. Ultimately, the company can maximize profits by assigning items to channels and brands to reach consumers at the lowest cost-to-serve.

Circuit City’s Opportunity
Rather than minimizing the cost-to-serve across channels, traditional retailers often put their most popular items on their Web site. Although such an approach sounds logical, the reverse would typically work better. Traditional store-based retailing requires turning inventory quickly to justify expensive floor space. Slow-moving inventory — especially products with a high risk of obsolescence — can benefit from the centralized inventory pooling of online retailing. And if the product commands a high value-to-weight ratio, the cost penalty from direct-to-consumer shipping is minimal.

Circuit City, the “big box” consumer electronics and small appliances retailer, has an opportunity to minimize its cost-to-serve by making smart use of its many service options: in-store shopping, in-store or online ordering with delivery from the store, online ordering with store pickup, and online ordering with direct home delivery. Consumer electronics is a category currently underexploited by e-commerce. In 2002, only 2.5 percent of electronics and appliances sales went through online channels despite the fact that many electronic goods share the high value-to-weight ratio of computer hardware and software. Finding the optimal cost-to-serve for each product and customer category would give Circuit City a competitive advantage over pure-play online retailers or less aggressive traditional competitors.

Circuit City operates a network of nine regional distribution centers to serve its 621 domestic stores. With average weekly sales of more than $300,000 per store, Circuit City generates overall cost savings from its transportation network scale. But the relative importance of this bulk shipping network varies by product.

Consider the Hitachi 65" HDTV Display recently offered at $1,299. It weighs 324 pounds and measures 5-feet-by-5-feet with a 28-inch depth. Shipment of such a bulky item through the company’s full-truckload distribution network offers significant savings over a small-package shipment directly to a consumer’s home via UPS. But, with relatively low unit sales and a short product life cycle, inventory held at the store represents a high cost and big risk. Circuit City might benefit from keeping a minimum inventory of this item at the store — even just a display model — and having customers order it online for in-store pickup after the next delivery from the regional distribution network.

A pure online offering might work best for the Sony HDV camcorder. Priced at around $1,999, it is the most expensive model among the 60-plus camcorders that Circuit City sells, and it costs three to five times the price of the most popular models. As with the Hitachi HDTV, low unit sales of the Sony HDV camcorder may not justify stocking the item at the store because of the high inventory-carrying cost and risk of obsolescence. But unlike the Hitachi HDTV, the camcorder weighs very little — less than two pounds — and, accordingly, Circuit City’s distribution network provides little transportation cost savings. Rather than stocking it at each of the nine regional distribution centers, Circuit City could gain further savings by pooling the inventory in a single national distribution center and shipping directly to customers’ homes, minimizing the cost-to-serve for Circuit City as well as for the customer.

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