Hugo Boss had a problem. The German clothing maker advertised to the retail chains buying its clothing that certain bodywear products—socks, T-shirts, underwear—would never be out of stock. Sometimes, though, they were.
Not that they were too far off: the average availability of these products was 97.9 percent. Still, the company was falling short of its 100-percent-availability guarantee, and executives worried that Hugo Boss’s retail partners, such as Finnish retailer Oy Stockmann, would substitute products from competitors, such as Calvin Klein, Polo Ralph Lauren, and Dolce & Gabbana. In 2006, when Hugo Boss was considering how to keep its in-stock promises, the bodywear division accounted for more than €33 million in sales to retailers.
To eliminate as much of that 2 percent of unavailability as possible, Hugo Boss worked with one of its manufacturers on an operational challenge that most suppliers choose not to pursue. It yielded huge results: a 13 percent increase in retailer demand for a 1-percentage-point improvement in service level, and a gain of more than €300,000 of profit margin for the products included in the project.
Given the complexities of global supply chains, retailing has to work like a precisely choreographed dance, connecting far-flung suppliers who make and distribute products, store buyers and marketers who display and advertise goods, and customers who ultimately decide whether to make a purchase.
Retailers stipulate that vendors deliver the goods they produce on time and in full, but vendors often slip in fulfilling those promises. Improving operations can be an expensive proposition, and many suppliers believe it doesn’t pay off. In an informal survey of 141 managers at a consumer packaged-goods company, 56 percent said that an improvement in their service to retailers would not increase demand for their products.
But academic research conducted with the cooperation of Hugo Boss, a supplier to many large international retailers, suggests that improving supply-chain responsiveness represents an overlooked opportunity.
Suppliers that deliver on their commitments to retailers can significantly boost demand.
“Manufacturers say, ‘I have a 95 percent service level, and to get to 98 percent, I’d have to invest so much money that it’s not worth it to me,’” says Nicole DeHoratius, adjunct professor of operations management at Chicago Booth. But she discovered that their assumptions are wrong: “[As a manufacturer,] the more consistently I’m able to fill the orders of my customers, the more demand I can generate.”
How supply chains fail
DeHoratius has worked with a variety of retailers, including Costco, Kroger, Target, Ulta, Walgreen, and Walmart, both as a consultant and as a researcher studying their inner workings. She focuses on how retailers and suppliers can work together more smoothly—and on what happens when supply-chain processes go awry.
When suppliers don’t deliver accurate, on-time orders, retailers lose time and money. If a particular item isn’t available, retailers may substitute a similar product from a competitor to fill bare shelves. If a supplier is consistently unreliable, retailers may feel the need to hold extra inventory, in case the next shipment is delayed. This practice ties up money that could be better spent on merchandise that can go immediately on the sales floor. If a supplier causes too many problems, the retailer may ultimately end the relationship.
Even when the right merchandise appears to be in stock, the inventory records may be wrong—and here, the blame may lie with either the retailer or the supplier. In a 2014 research report, the consulting group Forrester looked at online purchases that customers could pick up in stores. The report found that 61 percent of retailers were not able to fulfill as many as one in 10 of these orders because of incorrect store inventory counts.
Sometimes, suppliers send the wrong merchandise, and retailers don’t have the labor available to verify each delivery against a purchase order when it arrives in the stockroom, DeHoratius explains. They’re counting on suppliers to be accurate. If a vendor sends 12 blue eye shadows in a box that’s mismarked as 12 brown eye shadows, and that box is scanned in the retailer’s warehouse, the retailer’s computer system now thinks that 12 brown eye shadows are in the system. One purchase order in 10 has some sort of error, DeHoratius says.
On the retail side, cashiers’ mistakes can magnify supplier errors. If a customer goes to Target to buy a liter of Coca-Cola and a liter of Diet Coke, the cashier often scans one of the bottles twice. It doesn’t make a difference to the customer, since both bottles are the same price. But it wreaks havoc with the inventory system. “For every mistake like that, there are two inventory records that are wrong,” DeHoratius says.
Some of her research looks at designing systems that leave fewer opportunities for people to mess up the inventory records. Some retailers, for instance, have eliminated cashiers’ ability to log multiple items at once, forcing them to scan every product individually. When the records are correct, the products that need to be restocked are more likely to be ordered and shipped on time. Finding exactly what they want, customers go home satisfied—and everyone profits.
In the Hugo Boss research, DeHoratius focused not on how suppliers fail, but on how they can boost demand by getting things right. Can suppliers generate more demand from their retail customers simply by doing what they said they would? More importantly, can they fulfill their promises in a cost-effective way?
Making retail buyers happy
The Hugo Boss study developed from a connection DeHoratius made while teaching an Executive MBA Program class on operations and supply chains. In London, she taught Constantine Moros, who headed operations and procurement management for a Swiss division of Hugo Boss Group. He described a pilot project he was managing to improve the division’s supply chain, and he offered DeHoratius access to the field experiment. Moros then worked with DeHoratius, Harvard’s Ananth Raman, and Zahra Kanji, then a Harvard research associate, on a 2009 business-school case, using Hugo Boss as an example. That case described the importance of a high level of vendor service to retail customers. More recently, DeHoratius teamed up with Raman and Ohio State’s Nathan Craig for a more rigorous academic treatment of that case study.
The timing of the Hugo Boss pilot program allowed the researchers to determine how supplier service levels affect retail orders. Craig, DeHoratius, and Raman focus on the role of the retail buyer, the person ordering the bodywear that Moros was selling. The linchpin of retail operations, buyers have longstanding relationships with vendors such as Hugo Boss. They place orders based on sales data, as well as service level. The retail buyers also influence demand more subtly, by choosing products to feature in advertising circulars, and by making decisions about merchandise placement and store signage. “Decisions that buyers can make really influence the ability of the product to get to the floor undamaged, to be safe from theft on the store shelves, and to drive demand by the customer,” DeHoratius says.
Moros and the researchers worked together to compile figures from the Hugo Boss bodywear division. The data included approximately three years of information about every order the company received from retailers for bodywear products. The researchers also conducted interviews with executives and team members responsible for all aspects of the bodywear operations, as well as with more than 20 retail buyers.
During the pilot project, Moros and his colleagues worked with an Israeli manufacturer, Delta Galil, to improve the accuracy of shipments for Hugo Boss bodywear. The project focused on 45 bodywear items made by Delta Galil at a factory in Cairo for the Boss Black subbrand. Before the pilot, shipments of all the items from Hugo Boss to retailers that were promised to never be out of stock were delivered on time and in full at 97.9 percent.
To improve that percentage, Hugo Boss placed orders with Delta Galil more often, switching from monthly to weekly orders. This change allowed Hugo Boss to adjust its order quantities more frequently if particular items were running low at a warehouse. At first, Delta Galil managers were concerned that changing the system to smaller, more frequent orders would hurt production planning and diminish economies of scale at the factory. Eventually, though, Moros’s argument convinced them that the new system would create a more flexible and predictable production schedule with mutual operational and financial benefits.
Revenues rise, expenses fall
Placing orders with factories more frequently is counterintuitive for manufacturers. More-frequent orders could potentially lead to higher ordering and transportation costs, as trucks roll more often. The extra employee hours and the costs surrounding order placements may also contribute to higher expenses.
But that’s not what the researchers found at Hugo Boss. Once it switched to placing weekly orders with Delta Galil, Hugo Boss employees had a better idea of how much of each product they needed, which led to more-accurate deliveries to the distribution centers of their retail customers. Transportation and ordering costs decreased, because inaccurate forecasts no longer triggered pricey expedited shipping. In all, Hugo Boss’s expenses for the 45 items in the pilot project decreased by about 24 percent, the researchers calculate.
Improving service had a big impact on demand from retailers. When Hugo Boss improved its inventory service level by just 1 percent, retailers increased their average weekly orders by 13 percent. The project generated an additional €300,000 in profit margin for the items in the pilot, which substantially exceeded the costs of the project.
Buyers order more, the data show, from vendors they find reliable. “If you start meeting the needs of your retail customers, you can attain higher levels of demand,” says DeHoratius. “Managers that ignore the possibility of driving orders with service level increases will forgo potentially profitable supply-chain improvements as well as opportunities to capture market share,” she and her colleagues write in the Hugo Boss research.
When vendors fall short, the consequences can be severe. In their field research for the Hugo Boss study, Craig, DeHoratius, and Raman examined one retailer (which they didn’t name) whose buyer decided to drop a planned advertising circular for a product category that was receiving poor service from its suppliers, at a cost to the retailer of $14 million. The Hugo Boss study cites another example, of footwear manufacturer Nike, which lost orders when retail buyers shifted more of their purchasing to a competing brand with better inventory performance. Nike started a project called “Always Available” to raise its service level and win back buyers for frequently ordered products, such as socks and basic T-shirts.
Of course, what worked for Hugo Boss may need to be modified for another supplier, say, one delivering electronic components rather than bodywear. The tweaks needed to raise inventory service level can vary from one supplier to the next. DeHoratius cites information-sharing efforts such as collaborative planning and forecasting, tailoring orders on the basis of consumer preferences, and shortening lead times as other possible strategies for better matching supply with demand.
“In sum, we find historical supplier service level to be a statistically significant predictor of current demand,” the researchers write. DeHoratius adds, “Too often, vendors miss opportunities for generating additional revenue through improving their supply-chain management, because they’re so focused on the desire to simply decrease expenses.” The Hugo Boss field experiment demonstrates that one can use supply-chain change not merely to reduce costs, but also to provide additional value.