*only need help with Phase 2 #2 and Phase 3*

One morning, a Costco store in Los Angeles began running a little low on size-one and size-two Huggies. Crisis loomed.

So what did Costco managers do? Nothing. They didn't have to, thanks to a special arrangement with Kimberly-Clark Corp., the company that makes the diapers.

Under this deal, responsibility for replenishing stock falls on the manufacturer, not Costco. In return, the big retailer shares detailed information about individual stores' sales. So, long before babies in Los Angeles would ever notice it, diaper dearth was averted by a Kimberly-Clark data analyst working at a computer hundreds of miles away in Neenah, Wis.

"When they were doing their own ordering, they didn't have as good a grasp" of inventory, says the Kimberly-Clark data analyst, Michael Fafnis. Now, a special computer link with Costco allows Mr. Fafnis to make snap decisions about where to ship more Huggies and other Kimberly-Clark products.

Just a few years ago, the sharing of such data between a major retailer and a key supplier would have been unthinkable. But the arrangement between Costco Wholesale Corp. and Kimberly-Clark underscores a sweeping change in American retailing. Across the country, powerful retailers from Wal-Mart Stores Inc. to Target Corp. to J.C. Penney Co. are pressuring their suppliers to take a more active role in shepherding products from the factory to store shelves.

In some cases, that means requiring suppliers to shoulder the costs of warehousing excess merchandise. In others, it means pushing suppliers to change product or package sizes. In the case of Costco and Kimberly-Clark, whose coordinated plan is officially called "vendor-managed inventory," Kimberly-Clark oversees and pays for everything involved with managing Costco's inventory except the actual shelf-stockers in store aisles.

Whatever the arrangement and the terminology, the major focus for these big retailers is the same: Cutting costs along the so-called supply chain, which comprises every step from lumber mill to store shelf. The assumption is that suppliers themselves are in the best position to spot inefficiencies and fix them.

For consumers, it all translates to lower prices at the cash register. Indeed, big companies' increasing focus on the supply chain is one reason U.S. prices for general merchandise -- goods from laundry detergent to wool sweaters -- fell 1.5% in 1998 and again last year and are falling at the same rate this year, according to Richard Berner, chief U.S. economist at Morgan Stanley Dean Witter. "Supply-chain management has had a major impact," says Mr. Berner, who compiled his analysis from government data.

There is also a potential downside for consumers: Fewer choices in brands and types of packages. For example, two years ago, Kimberly-Clark stopped making separate diapers for boys and girls and reverted to unisex-only. Less variety makes for easier inventory-tracking in its factories and trucks, the Dallas-based company says.

To a great extent, better cooperation between retailers and suppliers has been made possible by improved technology -- such as the computer link Kimberly-Clark uses. It's also a consequence of the greater strength of major retailers as they consolidate and expand globally. Many economists say that closer retailer-supplier coordination on the supply chain is the model of the future and will ultimately determine which companies succeed in the new millennium.

"A shopper buys a roll of Bounty paper towel, and that would trigger someone cutting a tree in Georgia," says Steve David, who heads supply-chain work for Procter & Gamble Co., the Cincinnati consumer-products giant. "That's the holy grail."

These days, P&G stations about 250 people in Fayetteville, Ark., minutes from Wal-Mart's headquarters in Bentonville, solely to promote its products to the discount chain and ensure they move as quickly as possible to store shelves. The two giants share some inventory data.

The price of inefficiencies on the supply chain is high. Revlon Inc. this year slowed its product shipments because store shelves were backed up with older inventory. Kmart Corp.'s new chief executive, Charles Conaway, has publicly blamed the retailer's sagging profits in part on a weak supply-chain infrastructure. Last month, he said he expects to spend $1.4 billion over the next two years to update Kmart's technology, including systems for coordinating with suppliers. And earlier this year, Estee Lauder Cos. hired away Compaq Computer Corp.'s executive in charge of supply chain to bolster that operation at the cosmetics concern.

By several accounts, the close collaboration between Costco and Kimberly-Clark serves as a model for other merchandisers, and also helps explain strong recent sales gains by the two companies. In the past two years, Kimberly-Clark gradually expanded the program and now manages inventory for 44 retailers of its products. The consumer-products company says it wrung $200 million in costs from its supply chain during that period, and it vows to squeeze out another $75 million this year.

"This is what the information age has brought to this industry," says Wayne Sanders, chairman and chief executive officer of Kimberly-Clark. "It gives us a competitive advantage." In fact, Kimberly-Clark says the cost savings it achieves on its supply chain are one reason its Huggies -- and not rival P&G's Pampers -- are sold at Costco stores in most areas of the country.

"If a company finds a way to lower its costs, it gets those deals," says Richard Dicerchio, Costco's chief operating officer. A spokeswoman for P&G says its supply chain is very efficient, and Costco carries many of its other products.

To oversee ordering for the retailers whose inventory it manages, Kimberly-Clark employs a staff of 24 people, including Mr. Fafnis. A Kimberly-Clark spokeswoman says the benefits of the program "more than offset" additional labor costs. Last year, Kimberly-Clark posted a 51% rise in net income to $1.67 billion on $13 billion in sales, capping three years of improving results.

For Costco, the benefits of such close cooperation with a major supplier are equally clear: Costco saves money not only on staffing in its inventory department, but also on storage. Before Kimberly-Clark began managing Costco's inventory, in late 1997, the retailer would keep an average of a month's supply of Kimberly-Clark products in its warehouses. Now, because Kimberly-Clark has proven it can replenish supplies more efficiently, Costco needs to keep only a two-week supply.

What's more, Costco says its shelves are less likely to go empty under the new system. That's important for both retailer and supplier, because consumer studies indicate that a majority of customers will walk out of a store empty-handed if they can't find a particular item they need. P&G, for example, estimates that an average retailer's loss from out-of-stocks runs about 11% of annual sales.

For Costco, which keeps its costs down by typically offering just one brand-name product and its own private-label Kirkland Signature product in each category, maintaining supplies on shelves is crucial. "If we're out of stock, it means we're out of a category, so the chance of a loss of a sale is greater," Mr. Dicerchio says.

Susanne Shallon of Redondo Beach, Calif., says she always buys size-four Huggies for her 22-month-old daughter, Beth, and Pull-Ups for her five-year old son, Emil, at a nearby Costco because the store is well-stocked. "It's good to have the confidence that when I go into the store, the product will be on hand," she says.

For now, Kimberly-Clark manages inventory in Costco stores everywhere but the Northeast. Kimberly-Clark recently sent analysts to Costco headquarters in Issaquah, Wash., to push for a possible next stage: expanding to the Northeast and collaborating on forecasts, not just recorded sales.

James Sinegal, CEO of Costco, says the chain has always managed its inventory well, but "we want to take things to a higher level." Costco has been a star performer among U.S. retailers, posting double-digit sales growth every year since 1996. Its sales rose 13% to $26.98 billion in the fiscal year ended Aug. 29, 1999.

At Costco, diapers are known as a "pull" product -- meaning that shoppers make a trip to the store specifically to buy them. Parents are also particularly price-conscious, so the pressure is on for the retailer to keep diapers in stock and to make it as cheap as possible to do so.

For Mr. Fafnis, the 34-year-old Kimberly-Clark data analyst responsible for overseeing stock at 155 Costco stores across the Western U.S., that means arriving at his cubicle at 7:30 each morning to a stack of spreadsheets that show exactly how many boxes of Huggies, Kleenex tissues and Scott paper towels sit on the shelves. He's privy to more sales and inventory detail than many Costco executives can see.

His mission: to keep each store's inventory as low as possible without risking empty shelves. That allows him very little margin for error, as it takes an average of a week from the time he types an order into his computer until a truck pulls up to a Costco store.

Scanning the spreadsheets one morning a few months ago, Mr. Fafnis, who studies baseball statistics as a hobby, quickly spots the potential problem in Los Angeles. The store's supply of size-one and size-two Huggies is down to 188 packages; in the past week, 74 were sold. That means the store could drop below its safety stock -- typically, two weeks' worth of inventory -- within days. The computer spits out a suggested order, but Mr. Fafnis cuts it by a few packages. As the father of a two-year-old Huggies wearer, he has a certain instinct for the market. "When the next truck pulls in, you want to be right at your safety stock. That's the ideal situation," Mr. Fafnis says.

Mr. Fafnis, who has never been inside a Costco (there aren't any in Wisconsin), tries to tailor orders to shoppers' whims and the needs of particular neighborhoods. On a bulletin board in his cubicle, he posts a list of special requests heavily marked with orange highlighter. For example, a store in Reno, Nev., can receive deliveries only early Monday mornings to get around city noise ordinances.

After Mr. Fafnis enters orders in his computer, a Kimberly-Clark transportation analyst at the company's logistics center in Knoxville, Tenn., calls up the same computer file and assigns the order to a trucking company.

Complaints are handled by Kimberly-Clark customer-service analyst Rachel Pope, who sits a few cubicles away from Mr. Fafnis. One afternoon, a Costco merchandise manager calls to say that a store in Spokane, Wash., is under construction and doesn't want its delivery. Ms. Pope phones the logistics center in Knoxville, which tells her the truck destined for Spokane is already at a loading dock in Ogden, Utah. She reaches the driver, via conference call, just before he begins filling the truck. "This was close," she says.

The drive for efficiency creates new problems. Last year, Costco store managers complained that some deliveries were incomplete. Kimberly-Clark managers visited 13 Costco stores and spotted some drivers accidentally unloading items intended for a later stop. Now, Kimberly-Clark uses a simple cardboard divider to separate each store's order.

Scouting store shelves for out-of-stocks is Donna Imes, Kimberly-Clark's saleswoman for Costco. Ms. Imes, who lives near Costco's headquarters, typically logs in to her home computer at 4:30 every morning, scanning reports from Mr. Fafnis. She walks every aisle of at least five Costco stores a week, taking notes in a spiral-ring pad about displays and competitors' prices and chatting up store managers and customers.

Recently, when Ms. Imes saw shoppers stowing diapers on the bottom rung of their carts, she called Huggies brand managers to caution them not to make the packages wider. Noticing that a particular store often ran low on Depend incontinence underwear at the beginning of the month, a Costco manager told Ms. Imes that residents of a retirement center next door always shopped then. So she alerted Mr. Fafnis, who programmed his computer accordingly.

The importance of supply chain hasn't been lost on Kimberly-Clark itself, which is trying to apply the same principles to its own suppliers. These days, it keeps less than a month's supply of diapers in its own warehouses, down nearly 50% over the past two years.

For now, raw-material shipments remain the weak link. Advances are small, focusing on such details as how the company stocks Velcro tabs for its diapers. Two years ago, Kimberly-Clark began sharing its production plans with Velcro USA Inc. via weekly e-mails. That cut Velcro inventory 60%, saving several million dollars.

Kimberly-Clark says it's trying to cut costs further. Jim Steffen, the company's president of U.S. consumer sales, regularly reminds his staff that the retailer is the customer. "The last time I looked," he says, "we didn't own any stores."

Credit: Staff Reporters of The Wall Street Journal

PHASE 1:

Think of this part as a standard case study. Use it as a baseline for helping you understand the elements of Vendor Managed Inventory (VMI) and addressing the following questions:

Read the Wall Street Journal article above on Kimberly Clark and Costco.

Write an analysis of the article including, but not limited to the following points of interest:

What are the positives for Costco?

What are the negatives for Costco?

What are the positives for Kimberly Clark?

What are the negatives for Kimberly Clark?

Furthermore, address what industries, size companies, intermediaries and manufacturers would benefit or suffer from implementing VMI. Think of this as taking this beyond the Costco/KC relationship. Should a company think of this as a value added service or as a cost cutting investment? What has become of VMI since this article was written? Is it viewed now as an industry standard or is it a competitive advantage and differentiator?

Note: Think of this Phase as your information-gathering phase to assist you in the following phases.

PHASE 2:

write an ANALYSIS regarding the following scenario:

You are an executive of a mid-sized consumer product industry.You are approached by a large brick and mortar retailer, to put a line of your products into their stores in the Southeast region.

This is an 11 state region with 250 retail locations, all in metropolitan areas.The customer is offering a one year contract to begin and agrees to pay in full (not on account) all inventory once received at the agreed upon price and trust your management of the inventory stock levels at their retail locations. (Meaning - if you send it to them, they will pay for it)

1.You have been selected as the Program Manager for this project.Here is the data your customer and your internal groups have provided.

Requirement 1: Incorporate a SWOT analysis in your analysis and response

Requirement 2: Please include an executive summary to this section regarding your recommendation

1.The customer has received your pricing and requested / demanded at discount

2.The customer also expected you to manage the inventory in a VMI system

3.The quantity discounting will reduce your profit from $2.49 per unit to $1.74 per unit.The customer's forecast shows projected annual sales of 1,100,000 with an error of + 10%.

You reach out to your internal departments with the Inventory Management request.

Here is the response:

1.Your engineering department has sent you a list of equipment including office equipment for your new team members at $250,000.00

2.Your HR department has sent the new headcount costs to you at $449,000 annually.Training to onboard this team is set at $57,600.This includes the expected fall out (attrition) rate from training and the associated rehire costs.

3.Your requests for data on 11 remote office locations has been returned from an outside real estate firm at $39,600.00.This includes data hook-ups back to the main office.

4.Travel from your remote office locations to the customer's sites is estimated at $129,000.00.This estimate is based upon each location only being visited and audited 2 times per year.

5.Implementation and setup costs including travel at estimated at $250,000.00.

Is this project going to generate any profit in the first year?

What is the expected profit / loss at the end of the year?

What is the payback period in months / do they expand beyond the 1yr contract?

What is your recommendation, to accept or not accept the offer?Why?

What effect does the +10% demand forecast error have on your recommendations?

2. Assume you have taken the contract and address the following situation:

Your program has had problems with system link-up and connectivity off and on for the past month.

While there are no customer complaints to date, sales have some concern with the accuracy of the inventory numbers.Purchasing has also noted fluctuations in raw material expenditures and shipping costs to the customer.

During implementation you developed a relationship with a temporary labor agency that supplied temp labor to each location at a cost of $15/hour with a minimum of 4 hours billed. This does not include any costs for travel from your team to supervise.

The customer also introduced you to a company they bring in twice per year per location to do an inventory for tax purposes.You have contacted them and they would charge $1000.00 per location to give an accurate inventory, this cost includes manpower, travel and a one day turn around on data.

What do you recommend as a course of action and why?

PHASE 3

Address the following ethical dilemma - You are at the end of the third quarter, Sales has announced that your company needs to increase shipping 10% to the customer for the last quarter for your company to make its financial forecasts and budgetary commitments. You realize that your agreement with the customer is they will purchase any inventory you send since they are trusting your VMI system.

What do you recommend as a course of action and why?