4.9End-of-Topic Case: Applying the Strategic Profit Model to Scenario Analysis

RR Online (RR) is a successful outdoor equipment retailer that has experienced increased logistics costs due to its move towards omni-channel distribution. Omni-channel is presented in more depth in Topic 14, the overall principle behind omni-channel is that all channels in which your company sells have visibility of and access to all inventory in any of your locations, from stores to DCs. Omni-channel solutions can improve customer service and reduce the amount of inventory in the total internal network, however, they can also increase the cost of transportation dramatically.

Katie Lee is an experienced consultant hired by RR Online to help RR determine how to best improve its supply chain efficiency, while improving or retaining customer service levels. Katie has worked with some global leaders in omni-channel retailing. RR is one of her smaller clients. RR's management, including the logistics team headed by Hector Magellenez, has observed that in addition to the huge investment it made in IT to move to an omni-channel platform, it also has experienced other logistics costs increases. RR's financial statements are below:

RR Online Income Statement, 20XX
RR Example	Symbol	Base
(in millions)
Sales	S	74,452
Cost of Goods Sold	CGS	47,546
Gross Margin	GM=SCGS	26,906
Transportation	TC	6,635
Warehousing	WC	8,585
Inventory Carrying	IC=INW	4,733
Other Operating Cost	OOC	6,208
Total Operating Cost	TOC	26,161
Earnings before interest and taxes	EBIT	745
Interest	INT	239
Taxes	TX	161
Net Income	NI	345

Balance Sheet: Year Ended December 31, 20XX
Asset Deployment
Cash	CA	8,658
Accounts Receivable	AR	4,767
Inventory	IN	7,411
Total Current Assets		20,836
Fixed Assets	FA	10,949
Total Assets	TA	31,785
Liabilities
Current Liabilities	CL	18,848
Long Term Debt	LTD	3,191
Total Liabilities		22,039
Stockholder's Equity	SE	9,746
Total Liabilities & Equity	TL	31,785

In talking to Hector, as well as with the DC managers, Katie has discovered that there is some extra labor and space availability at the DCs. One possibility to cut transportation costs is to transship items from various locations to a DC as a bulk shipment. At this consolidation center, multi-item orders could be assembled and shipped to the customer's door (home or retail). Based on prior experience, Katie has estimated that this consolidation option will save about 8% in transportation costs.

Katie would also like to improve the efficiency of DC operations. She believes that RR could improve its overall space utilization, freeing up space that could then be leased to other companies. In other words, RR would get into the warehousing business. Katie estimated that if RR pursued this strategy, warehousing and inventory would be reduced by 10% and 5% respectively. The downside to this scenario is that RR would need to use more vertical space, which makes the order-fill process a bit slower. However, Katie isn't too concerned with this fact. After all, RR's DC workforce is underutilized and has some spare time available. She is confident that the customer would not experience a difference in service level.

Katie's third alternative is to improve the training of the distribution center team to reduce the errors in order fill. She would like her more-highly trained team to update the inventory quantities through daily cycle counting. Katie's experience indicates that there will be no additional costs associated with doing this, but that net sale and COGS will each increase by 2% and inventory will increase by 1% to help with the improved fill rate. RR will not need any additional transportation, as it will be able to ship more complete orders, thereby reducing the number of split shipments. RR will also not need additional warehousing, as it currently has extra capacity. Thus, transportation and warehousing costs will remain the same.

If only it was this simple! As Katie was concluding her final facility visits and interviews, she met Vikram Nagoo, the VP of Merchandising. He told Katie that under no circumstances could RR reduce the size of orders being placed with suppliers without incurring price increases from suppliers. He also warned Katie that now that store managers have better visibility of company-wide inventory, they are trying to reduce their inventory. Vikram commented, "Since store managers are evaluated on their store-level ROA, which includes their store inventory, but not items ordered by customers in the store for home delivery and pick-up, they will be doing everything in their power to push inventory back to the DCs."

Questions

Help Katie present the profit-leverage effect concept to RR management. How should she explain it to them so that they can truly understand the equivalent sales impact of logistics?

Use the Strategic Profit Model to calculate the balance sheet, income statement and key ratio effects for each of the scenarios. Develop a recommendation for Katie to present to top management, including the aspects of the SPM she should present, and why.

What potential goal conflicts would your recommendation create- among merchandising, logistics, and stores?

Identify two common metrics that merchandising, logistics, and the store could share that might reduce existing conflicts. How would these metrics reduce conflict?