When the ratio of U.S. business inventories to sales dropped to its lowest level in four years in March, the report highlighted the enormous success retailers and manufacturers have had in scaling down supply chains to match declining consumer demand in the downturn.
It also underscored the high stakes shippers and carriers face in the coming months as they try to measure the prospects for a sustained recovery and how to build distribution channels to better match supply to demand.
U.S. companies dropped nearly $70 billion of inventories from their books in the year ending March 31, including $37 billion worth of retail inventories, according to the U.S. Census Bureau. Retailers pushed more goods through their networks in March than they did in February, but still added only about $8.4 billion in inventories while expanding sales by nearly $50 billion from month to month.
That amount may be the gap between the business that’s moving and what operators across the transportation world believe may be possible if the gathering recovery in shipping demand proves to be more than a simple restocking of depleted inventories.
But many retailers, fresh from thinning out supply chains in record time, now are trying to figure out how to have the best of both worlds: the efficiencies they gained during the downturn, while taking advantage of the opportunities of recovered demand.
One retailer, Home Depot — No. 3 on the JOC’s list of Top 100 Importers — believes it found the answer with a supply chain transformation that began before the downturn and that continued without interruption even as the home improvement giant faced the full impact of the decline in the housing market.
In 2007, Home Depot began a massive reconfiguration of its North American supply chain. Three years later, most of the home improvement retailer’s goals have been met or soon will be. The cornerstone of the company’s evolution from a direct-to-store distribution model to a central distribution model is a network of what it calls Rapid Deployment Centers — flow-through facilities designed for cross-docking and rapid distribution of high volumes of merchandise.
Of the 19 planned RDCs, 13 are up and running, stretching from the East Coast to the West Coast and with several in the middle, and covering 70 percent of Home Depot’s stores. By the end of the year, the company said, the RDCs will serve the entire country.
The facilities are new nodes in a developing network that carries Home Depot’s ambitions across the breadth of its U.S. distribution chain.
The redesigned supply chain, which also includes new supply chain technology systems and processes, is transforming the world’s largest home improvement specialty retailer from what some saw as something of a logistics anachronism into a nimble supply chain leader.
The Atlanta-based company, ranked 25th among Fortune 500 firms, is the second-largest retailer in the U.S., behind only Wal-Mart, with 2009 sales of $66.2 billion. There are 2,244 Home Depot stores worldwide including 1,976 in the United States. The company opened six U.S. stores during fiscal 2009, which ended Jan. 31, 2010, and was a miserable year for the home improvement market because of the collapse in home sales nationwide.
It may not have been the best year to measure supply chain efficiency, but Home Depot showed the results of its efforts. Although overall sales were down 0.3 percent, the company cut nearly $500 million in inventories, or 4.5 percent, from its balance sheet during the year.
At Home Depot, inventories jumped $1.3 billion in the fiscal first quarter ending May 2, a 12.7 percent jump that suggested the company was moving rapidly to meet the sudden upturn in sales demand this spring.
Erratic weather in parts of the country tested the network in the quarter, Chairman and CEO Frank Blake said. “The flexibility and responsiveness of the supply chain were critical in meeting these changing needs,” he said in a conference call with Wall Street analysts. “We improved our inventory turns and improved our targeted in-stock levels during a challenging season. The whole replenishment process is improved.”
The retailer’s closest competitor, Lowe’s, has seen similar results after watching its inventories inch up slightly last year amid a slight decline in sales. But Lowe’s inventories jumped 9.8 percent in the first quarter because of what President and Chief Operating Officer Larry Stone called “opportunistic purchases” to meet new demand.
“Overall, we feel we have the right inventory in place to serve customer demand, and we expect our inventory position to be in line with our plan by the end of the year,” Stone told investment analysts this month. “We felt like to have the product in stock for the customers was worth an inventory investment.”
Both companies are buffeted by a volatile U.S. housing market — housing starts grew 5.8 percent from March to April while building permits fell 11.5 percent on a month-to-month basis — but even general merchandise retailers are facing similar questions.
Wal-Mart enacted what it calls a “significant inventory reduction program” in 2009, cutting its inventory measure 8 percent over the 12 months ending Jan. 31, 2010. But inventory grew 3.2 percent in its fiscal first quarter against a 6 percent gain in sales.
For the retail world as a group, that added up to an inventory-to-sales ratio of 1.31 in March, and when all business inventories are included, the ratio was 1.19, based on figures unadjusted for seasonal and other changes. In February 2009, the overall inventory-to-sales ratio was 1.61, the highest it had reached in 15 years.
Home Depot’s RDC strategy is not aimed so much at reducing inventories as it is directing goods to the right stores at the right time for the best possible sales.
RDCs are about up-to-the minute needs, in contrast to the less-than-truckload transit centers they replaced. Goods are shipped from the RDCs within three days of arrival; the old transit centers received orders weeks in advance of distribution to stores, said Mark Holifield, Home Depot’s senior vice president of supply chain.
The RDCs serve some 70 percent of Home Depot’s U.S. stores, with each facility serving about 100 stores. The RDCs average 485,000 square feet, although some are as large as 650,000 square feet. Unlike the LTL terminals and cross-dock facilities, goods are broken down and allocated to stores on a last-second basis at the RDCs.
For stores served by RDCs, about 38 percent of the cost of goods sold is shipped through the RDC, with a near-term goal of 50 percent, said John Deaton, vice president of supply chain development.
Before embarking on the supply chain project, Home Depot studied distribution models used by best-in-class retailers, particularly in the fast-moving grocery sector. The company identified four distribution capabilities, or flow paths, it would need to effectively serve its U.S. stores: RDCs, direct-to-store truckload shipments, lumber/bulk distribution facilities and stocking warehouses.
In 2007, 80 percent of the company’s goods were shipped from vendors directly to stores, a slightly chaotic system that left each store at the mercy of vendor minimum-order quantities. The vendor minimums were a huge source of frustration for stores, forcing them to choose between overstocks or out-of-stocks.
“Because of a lack of central distribution model, efficient logistics required minimum-order quantities that were excessive for many stores,” Holifield said.
The flow distribution model has led to significant reductions in product handling and lead times. The RDCs hold barely any inventory, and goods are shipped to stores within three days of arrival. The company’s fixed costs and capital investments are lower because the RDCs are smaller and less expensive to develop and operate than traditional big-box DCs.
Because the RDCs can build bulk orders for at least 100 stores, the stores’ product needs are met with a single purchase order and single electronic verification of delivery rather than hundreds. By allowing for rapid allocation and deployment of inventory to individual stores upon arrival at the center, the RDCs have led to improved transportation efficiency.
|Executives won’t say exactly what the RDC strategy has meant for Home Depot’s finances, but clearly the company believes it is pushing benefits to the bottom line.
“We have really never broken out the cost of the supply chain transformation because it is all part of what we are doing from a merchandising transformation perspective,” Chief Financial Officer Carol Tome told investment analysts on a conference call this year. “We are well on the path to reach (the) long-term targets we have given. So as the facilities come online and start to pay for themselves, we are adding more facilities obviously to build this out throughout 2010. . . . While we have done a really nice job I think on inventory, we have some inventory opportunities coming at us in 2011, too.”
She said on a per-store basis, inventory fell 3.3 percent last year and inventory turnover was 4.1 times, up one-tenth from last year.
“This was our first annual increase in inventory turnover since 2001, a true team effort,” Tome said. “We view this as solid performance as our in-stock position is at a record high level.”
Home Depot’s supply chain operations in the Chicago metro area offer a glimpse into the efficiencies it has gained through rapid flow distribution. Before the redesign, the Chicago area was served by five distribution platforms: import DCs, lumber DCs, carton DCs, pick-and-pack centers and transit facilities. There were seven management teams in place and multiple deliveries to the same stores.
Today, the network serving metropolitan Chicago includes three integrated operations: an RDC, a lumber/bulk DC and a stocking DC campus. The seven management teams have been reduced to three, and deliveries to stores are consolidated.
Ordering practices between Home Depot and its vendors have been simplified. About 450 vendors are aligned with RDC ordering processes and have adjusted their process flows to run the bulk of their products through the RDCs. The company hopes to have more than 600 vendors on board by the end of the year.
In fiscal 2009, the company added 5.2 million square feet of distribution space in the U.S., primarily for the seven new RDCs opened in the period, and eliminated 2.4 million square feet of space by shuttering conventional DCs.
In addition to the RDCs, the company utilizes three other flow channels, including direct-to-store shipments, which in the bad old days of 2007 represented a whopping 80 percent of the company’s cost of goods sold. The goal, established at the outset of the redesign process to bring direct-to-store shipments down to 25 percent of cost of goods sold, is on track to be met this year, Deaton said.
The company operates 26 lumber/bulk distribution centers in the U.S. for goods shipped on flatbed trucks. The lumber/bulk DCs handle about 7 percent of cost of goods sold, with a target figure of 10 percent Home Depot also maintains 13 stocking warehouses for handling goods with variable demand and long or unpredictable lead times. Products are shipped from the stocking DCs to the RDCs, and then to stores.
“That allows us to maintain our transportation economics by shipping more frequently and with fuller trucks,” Deaton said.
Supply chain processes in place in 2007 have been upgraded significantly. In those days, everything was store-centric; each store was responsible for its own ordering and inventory replenishment. That added up to a lot of ordering and a lot of LTL shipments; each stores stocks 30,000 to 40,000 SKUs, mostly building materials, home improvement and lawn and garden products. The stores on average contain 105,000 square feet of enclosed space, plus about 24,000 square feet of outside garden area.
A consequence of the store-based system was that, companywide, more than 30,000 employees, were authorized to place orders for inventory to be shipped to individual stores. At the same time, stores continued to be squeezed by vendor minimums, caught between overstock and stock-outs.
Logistics cost and service levels came under additional pressure when the economy began to worsen, especially the hard-hit home construction industry on which the company relies.
In assessing its then-current distribution and logistics network, the company concluded that its supply chain was at a competitive disadvantage; that it was incurring excessive warehousing, transportation and inventory costs; and that the situation could only be reversed through network reconfiguration. The most immediate challenge was to raise the volume of goods flowing through its own distribution network.
From the beginning, the company set a goal of moving 75 percent of the cost of goods sold through central distribution channels, including 50 percent through the RDCs.
Stores no longer have to fend for themselves; a new central replenishment structure manages about 70 percent of each store’s products.
When the company first considered supply chain transformation, it identified four benchmarks for gauging the project’s success — having goods in stock for customers, improving inventory turnover times, lowering fixed and variable logistics costs, and improving service levels to the stores.
While Home Depot doesn’t break out its in-stock or inventory turnover ratios, the RDCs are on track to meet all of the benchmarks in those areas, Deaton said.
Contact David Biederman at email@example.com.