1. Online Shopping—The growth of the Web and mobile devices allowed retailers to bring their product catalog straight to the consumer. Through online shopping, customers could then complete the sell-side activity entirely at home, which meant no visit to the store. Early on many assumed, mistakenly, that this was just a replacement for the mail-order business and would remain a niche market. Were they wrong! The ease and convenience of online shopping grew quickly and in 2017 accounted for 15 percent of all U.S. retail sales. The Pew Research Center reports¹ that 80 percent Americans are online shoppers and 15 percent buy online on a weekly basis. Unfortunately, online shopping was not compatible with a retailer’s existing supply chain and logistics operations, making it difficult for them to organically expand into the online space.

Why could they not just use their existing supply chains? Retailers hold inventory in two locations: stores and distribution centers, and their logistics networks are designed to efficiently bring the product to the store. During the 1990s, Walmart built a highly efficient network of cross-dock facilities to quickly replenish store inventories. Likewise, the apparel retailer H&M built warehouses, IT systems, and gathered a trucking fleet, for daily replenishment of store inventories. These are just two examples of the wonderful supply chain and logistics innovations that brick-and-mortar retailers had implemented. The problem is many of these innovations were a misfit for the logistics of online shopping, and for many retailers, their core competitive advantages did not transfer to the new economy. The shipment volumes, packaging, and destination are not just different, they are completely different. Even the customer is different, for a brick-and-mortar supply chain it is the store, for an online retail supply it is the actual customer. Sure, they could fulfill orders from their stores and distribution centers but it was not fast, and fast is what the online shopping customer wanted.

Almost no retailers are safe from the shift to online shopping. Products that we would have assumed could not be sold online are now being successfully sold and delivered. Take the case of Casper, which is selling mattresses online and shipping orders within 24 hours. The product is designed certainly for comfort, but also for shipping ease, and requires no special delivery service.

2. Point-of-Use Delivery—Retail supply chains come to a screeching halt at the store, then you the consumer drive to the store, pick up the item and take it to the point-of-use. In logistics vocabulary, the consumer is performing their last-mile delivery. Online shopping changed this process; customers wanted their purchases delivered to their home, office, dorm room, or anywhere. The range of delivery options and delivery speed are key determinants of online shopping convenience, and these may at times trump other factors such as price and quality. Dominos is very likely not the best pizza in your town, but more than likely it’s the highest revenue pizza store. Why, because of the convenience and reliable efficiency of its delivery infrastructure, both of which are key business differentiators for Dominos. Sure, the gourmet family owned pizzeria can hire a delivery driver for the evening rush, but the strategy is not scalable. The pizzeria is focused on its store customer and is never able to match the speed and reliability of the Dominos delivery service.

Retailers are not in the point-of-use delivery business, except when the product is too large or heavy, even then it is usually an outsourced service. For any retailer the logistics impact of point-ofuse delivery was enormous, a massive supply chain focused on brick-and-mortar stores would have to be rebuilt. The paradigm shift was radical, existing retail supply chains could not be just realigned, repositioned, or restructured; they would have to be built anew. Most Amazon shoppers today don’t bother to check any other shopping websites, they have full confidence that Amazon’s fulfillment system will deliver faster than anyone else.

3. Earlier Bulk Unitization—Once a bulk pallet leaves the factory, it progressively gets broken down into a retail unit and the supply chain infrastructure is designed to optimize this breakdown process. In each movement link, the associated vehicles and logistics facilities are designed to handle and move packages of a specific size. A bulk warehouse will move pallet loads efficiently but not box loads and certainly not unit loads. Distribution centers are the central node in a brick-and-mortar supply chain, and typically pallet loads are broken into box loads. Fulfillment centers provide a similar function in online retail, breaking box loads into unit loads.

In online retail, the bulk unitization process starts much earlier, and the supply movements handle much smaller packages (Figure 1.2). This also implies that a much greater number of packages must be moved and tracked, given a fixed sales volume. An efficient fulfillment center needs to cost-effectively move single units of a product. The operational impact of earlier unitization is significant. When a distribution center pretends to be a fulfillment, the economics can be disastrous and fast fulfillment is just not feasible. One innovative solution used by many distribution centers is task interleaving, which can improve operator utilization. But this works best when a high volume of full pallet loads is being moved and is of less value when the pallet loads are unitized earlier. The reality is that a distribution center cannot move and stock a single toothbrush, but a fulfillment center can. Let’s say toothbrushes are bulk packed in boxes of 100 units and a pallet of 10 boxes. Then, for a throughput volume of 1,000 units, a distribution center requires 11 product movements, but in a fulfillment center, the same volume will require 1,010 movements. The distribution center is simply not designed or equipped to execute a 100× increase in product movements.

4. Free Shipping—A retailer’s supply chain costs end at the store. Delivery to the home or last-mile delivery was only available at an additional cost. Delivery was offered as an external or add-on service and usually not an integral part of the retailer’s supply chain and logistics infrastructure. The add-on delivery was provided by a third party, either a local company or with a national network. The three largest last-mile delivery companies in the United States are USPS, FedEx, and UPS. Their retail shipment rates are a function of speed, and a quick check reveals they are steep for guaranteed three-day delivery (Table 1.1). We can assume that negotiated wholesale shipping rates are a fraction of retail rates, but they certainly are not free. The shipping cost for online orders, whether fulfilled from the store or a central facility, is therefore dependent on the cost efficiency of a third-party service provider. All of this was OK as long as the customer was willing to pay for the service.

In 2002, Amazon started offering free shipping on orders above $99, but that in itself was not a novel concept, but certainly, it cracked the online shopping barrier for many customers. But in a brilliant move, Amazon Prime was launched in 2005, offering free shipping for an annual membership fee.² At the start of 2018, there were an estimated 70 million Prime subscribers in the United States. This single move dealt a fatal blow to many brick-and-mortar retailers. The perceived cost disadvantage of an online order was neutralized, and the paradigm of free shipping was a threshold requirement for customers. Retailers could no longer consider last-mile delivery as a recoverable supply chain cost, it had to be built into the price.

5. Variety Multiplication—Henry Ford famously said, “Any customer can have a car painted any color that he wants so long as it is black.” His reasoning was simple, by having a single color, he could achieve economies of scale on the production side and supply chain efficiency on the sell side. Likewise, shop floor sales metrics and supply chain efficiency limit the variety of products a physical store can offer. The variety includes options in multiple dimensions: brands, style, colors, product features, and accessory add-ons. Slow-moving items are not pushed out by fast-selling items. If we only sell only one of that weird looking iPhone case per month, it’s just not economical to maintain in-store stock. But if the demand for that same iPhone case is aggregated for the entire retail market, it adds up to 20 a month. In that case, it is an economically viable product for an online retailer, who can then stock it at one of its fulfillment centers.

By stocking small quantities of a wider variety of product choices, an online retailer can attract customers who are not happy with the store choices. If the brick-and-mortar retailer tries to match the online retailer variety, a bunch of problems could arise. First, higher logistics cost to process the low unit volumes; second, lower revenues per square foot from slower selling varieties; and third, more clearances for unsold inventory. Online retail aggregates the dispersed insignificant customer into a significant one. Recognizing that they can effectively market low-demand items in an online channel, many manufacturers have already multiplied their product variety. The marketing advantage of “available online in 12 colors” compared to two colors in the store is clear.

Stock keeping units (SKUs) represent a unique product option, and the number of available SKUs is indicative of the stocked product variety. Looking at the in-store and online SKU availability for specific product classes at several brick-and-mortar retailers (Table 1.2), the variety multiplication effect is self-evident. The ratio of online/in-store SKUs ranges from 2 to 10+. When we extend the comparison to the variety on Amazon the multiplication continues, the online SKU ratios range from 2 to 6+. Yes, it’s only four products, but we checked, and the ratios are consistent across many common product classes. From a marketing perspective, products are being de-commoditized in the online catalog. The supply chain impact is huge, successful online retail entails stocking more product options and shipping in smaller volumes.

6. The Warehouse Is the Store—A couple of years ago, I visited a local wine store. The owner had recently launched a website for online orders and was offering attractive prices on mixed cases. Orders were pouring in! Open cases were scattered throughout the store, the owner and his two associates were running around with printouts, picking up bottles from shelves, and rushing to fulfill the orders. They had converted the store into a warehouse and collateral damage alienated their regular store customers. It was BOFS or Buy Online and Fulfill from a retail Store. But this is an inefficient solution when scaled up to process thousands of orders. Imagine if your neighborhood Walmart had to fulfill a couple of thousand orders every hour, shoppers would be tripping on boxes and bumping into pickers. A retailer’s most valuable asset is their stores, and their online strategy frequently attempts to leverage this asset. But in a paradigm shift, the store has limited utility to an online retailer. Yes, Amazon has recently opened stores and bought Whole Foods. While many pundits have opined on this strategy, I believe few outsiders of Amazon know the end game of this plan. A recent article³ describes a new class of retailers—Online Retail Plus Showrooms—sales are online but customers can visit physical showrooms to experience the product. Examples include Warby Parker and Bonobos. This is not a store is the warehouse strategy; the store functions only as a showroom for the customer who needs to touch and feel the product before making that buy decision.

When customers visit a retail store, they browse through the aisles picking up the items they need. In online retail, this function is transferred from the customer to a picker in a fulfillment center. In a fulfillment center, items are stocked in single units throughout the facility, and an army of pickers respond to customer orders and collect the needed items. Depending on the operational design, a single picker could work on a single order or multiple orders, or multiple pickers could work on multiple orders concurrently. The warehouse has become the store, and a distribution center cannot be reconfigured to do this efficiently.

An online grocer analyzes buyer behavior and decides to categorize its catalog into four groups (A-Packaged Goods, B-Liquid Items, C-Bulk Goods, and D-Others). The groups were selected such that 80 percent of customer orders include items from at least three groups. Figure 1.3 shows a warehouse design that facilitates order picking for fast fulfillment. Items with highest order frequency are located closer to the central aisle. The design looks more like a store and is radically different from a traditional warehouse. The online grocery pioneer Peapod illustrates this shift from brick-and-mortar to pure online. In new markets, Peapod fulfills orders from mini fulfillment centers or warerooms located within local grocery stores (owned by their parent company); when a market matures, they build a dedicated fulfillment center to accelerate the fulfillment efficiency. FreshDirect is a pure online grocer serving the metro New York market from two fulfillment centers. A 2012 New York Times⁴ article documented the flow of a grilled salmon salad through their fulfillment center, organized in a warehouse in the store format. The layout and design are optimized specifically for online orders, clearly a similar efficiency could not be achieved by a BOFS solution.

7. Predictive Correlations—An online customer has no anonymity; every transactional detail and every aspect of their shopping behavior are recorded. We are all described in megabytes of data, which are being processed by a data analytics program somewhere. Retailers have been collecting point of sales data for years and have been effectively extracting sales intelligence. A classical business school case study describes how Zara leverages real-time sales data to trigger its fast-moving supply chains. But for online sales, these data are 10-fold larger in size and much richer in terms of the descriptive attributes. A deep analysis of these data allows a smart online retailer to optimize multiple decision points in its supply chain and logistics system.

Three entities link to an online customer’s purchasing data (Figure 1.4): Product—what they bought; Location—where the product was delivered; and Time—when they made the purchase. By correlating this data with the millions of other customers in the database, we can identify who their online retail twins are. These correlations can then be used to make speculative predictions of future demand behavior. One of the earliest innovations on the Amazon bookstore was customers who bought this also bought this, that simple correlation has evolved into the data-driven marketing or product recommendation engine. Aside from their marketing value, these correlations can be exploited to achieve higher fulfillment efficiencies. If orders for an item are trending up in the New York metro area, then using the customer correlated data we can predict the behavior of that trend over the next few days. Inventory can then be accordingly positioned in nearby fulfillment centers. When an item is frequently bought with a basket of other items, then it can be stocked in closely clustered locations for faster order picking. Correlations are more significant in aggregate datasets, and many will not show up in individual store data. Predictive correlations allow the online retailer to design and operate an intelligence-driven supply chain.

8. Supply Chain Subscription—Building a supply chain infrastructure whether for brick-and-mortar or online retail is a capital-intensive activity and only perfected over time. The supply chains of Home Depot and Walmart are legendary, and their methods are highlighted in textbooks and magazine articles. Product manufacturers gravitate toward retailers with efficient supply chains, knowing fully well that fewer stockouts and fast replenishments are good for business. When LG entered the U.S. home appliances market in 2003, they evaluated retailers for retail placement, intending to build their brand. In addition to Home Depot’s broad retail presence, its strong supply chain and willingness to collaborate on logistics issues made it a preferred retail partner. Small or start-up retailers are typically shut-out of big-box retailers until their product is a proven success. One of the few exceptions, though, is Whole Foods that does embrace small manufacturers. The success of Whole Foods shows that a strong supply chain retail partner can enable success for a small producer or manufacturer with an excellent product. Their local leaning procurement strategies lets the small producers subscribe to the Whole Foods fulfillment system⁵ with healthy profits and growth opportunities.⁶

Amazon changed the manufacturer–retailer relationship with the launch of the Fulfillment by Amazon service in 2006. For a monthly subscription fee, small businesses and individual sellers could use Amazon’s fulfillment supply chain and its associated logistic facilities and software. The retail placement power of a retailer was effectively neutralized. A manufacturer, of any size, could in a matter of weeks have a superefficient online fulfillment supply chain. Instant Pot is the fairy tale story of this transition. Robert Wang and his team focused on inventing and manufacturing an exciting new product, and then in October 2010, they launched it on Amazon.⁷ Success came quickly, in 2016 they sold and fulfilled 215,000 Instant Pots on Prime Day. By subscribing to the Amazon supply chain, they did not have to spend much effort on supply chain and logistics issues. Instead, they spent their time scanning customer reviews and reinventing the product. Wang proclaims, “every 12 months to 18 months, we introduce the next generation of Instant Pot incorporating feedback from our real customers.” The supply chain has been democratized, and every inventor, every craftsman, and every entrepreneur can in an instant distribute their goods everywhere all the time.