Retailers know that everyone makes mistakes, including suppliers. But few retailers anticipate supplier errors in their formal inventory plans, and research suggests this could be costing them money.
Nathan Craig of Ohio State University, Chicago Booth’s Nicole DeHoratius, Northwestern’s Diego Klabjan, and Northwestern PhD candidate Yan Jiang looked at common fulfillment errors that retailers correct within their own distribution centers, such as wrongly coded boxes. They find that by analyzing these correctable errors, as well as the true costs of correcting them, retailers can adjust incentives and inventory policies to improve supply-chain performance.
Although correctable errors don’t require returns to the supplier—as would an uncorrectable error, such as a shipment that arrives damaged—they can nonetheless be pricey for retailers, as they can mean additional labor and longer-than-expected restocking lead times, among other complications. Such errors are relatively common: in an earlier study, the authors find that 7 percent of a retail chain’s purchase orders were affected by fulfillment errors, 56 percent of which could be corrected by the retailer itself.
To recoup some of the expense of those mistakes, retailers often charge suppliers “charge-backs,” preset fines for each type of fulfillment error they are forced to correct. But the researchers find that these fines often don’t reflect the actual costs of correcting errors. This can potentially distort incentives among suppliers, as well as make certain metrics, such as a supplier’s accumulated charge-backs, unreliable indicators of performance.
Retailers could minimize errors in the first place by understanding how purchase-order characteristics affect error rates, the authors argue. Some errors increase in frequency as order quantities go up; others become more frequent as order quantities diminish. Knowing how order size affects the incidence of errors can help retailers assess the optimal quantities for their purchase orders and drive down the costs of correcting problems.