What Zappos.com can teach us about the Supply Chain

Over the holidays I read Tony Hseih’s excellent book Delivering Happiness.  Tony, of course, is the CEO of the fast growing on-line footwear retailer Zappos.com.  The book has been widely read and discussed.  For most people the key takeaway is the lessons learned about Zappos strong corporate culture and excellence in customer service.  However, there is also a lot to be learned from the approach Zappos.com takes to the supply chain.

Drop Ship

Originally Zappos used a drop ship model for as many customer deliveries as possible.  In 2003, 25% of Zappos sales were coming from drop ship.   Tony commented that “The drop ship business was easy money.  We didn’t have to carry inventory so we didn’t have any inventory risk or cash flow problems with that part of the business.  But we had plenty of customer service challenges.  The inventory feeds that we were getting from our vendors for our drop ship business were 95% accurate at best, meaning that we would not be able to actually fulfill 5% of all of our drop ship orders.  On top of that, the brands did not ship as quickly or accurately as our own WHISKY warehouse, which meant we had plenty of unhappy and disappointed customers.”  In the early days during the dot com era, Zappos found that many of the brands they wanted to carry could not drop ship.  The manufacturers were set up only to ship orders directly to retail distribution centers (or stores).  Furthermore, the more popular shoes from the bigger brands which had drop ship capabilities were often sold out.  The inventory and cash flow advantages of drop ship have led many retailers to use such an approach for B2C e-commerce, but as you can see from Zappos experience there are numerous disadvantages to customer service as well.

Warehousing and Inventory Management

Originally, Zappos outsourced order fulfillment and inventory management to eLogistics.  The dot com company had acquired warehouse space next to the UPS WorldPort hub in Kentucky.  Proximity to WorldHub enabled eLogistics to offer lower shipping costs and faster order delivery.  As Zappos grew, the management team became frustrated with eLogistics leading the retailer to transfer responsibility for warehouse operations to an internal team.  Zappos opened its own warehouse to compete against eLogistics, which eventually shut down.  Tony commented on the decision by stating “As an e-commerce company, we should have considered warehousing to be our core competency from the beginning.  Outsourcing that to a third party and trusting that they would care about our customers as much as we would was one of our biggest mistakes.”  Another interesting dimension to Zappos warehousing operations is that customer service and order fulfillment times the top priority above traditional retail metrics such as inventory turns.  Tony stated that “We run our warehouse 24/7, which actually isn’t the most efficient way to run a warehouse…but we’re not trying to maximize for picking efficiency.  We’re trying to maximize the customer experience, which in the e-commerce business is defined in part by getting orders out to our customers as quickly as possible.”

Vendor Relations

Perhaps, the most intriguing aspect of Zappos’ supply chain operations is the vendor relations program.  Zappos takes a very different approach to supplier relationships than many of its peers in the retail industry.  “The typical industry approach is to treat vendors like the enemy.  Show them no respect, don’t return their phone calls, make them wait for scheduled appointments, and make them buy the meals.  Scream at them, blame them, abuse them…anything to get as much as possible and squeeze out every last dime.”  However, Zappos seems to understand the principles Martin Christopher of Cranfield University often states, which is that “Supply Chains Compete Not Companies.”  Zappos managers in the book state that “If vendors can’t make a profit then they don’t have money to invest in research and development, which in turn means that the products they bring to market will be less inspiring to customers, which in turn detriments the retailer’s business because customer’s aren’t inspired to buy.  People want to cut costs and negotiate aggressively because there’s a limited amount of profit to be shared by both sides.  As a result of this ‘death spiral,’ most retailers fail.”

When vendors visit Zappos headquarters, they have a car pick them up at the airport, provide a tour of the offices and always pick up the dinner check.  Tony explains that “The benefits we’ve reaped from concentrating on building relationships with our vendors are endless…When inventory’s scarce, they help procure inventory on hot-selling items…They work closely with our marketing team to plan the right campaigns, making sure we’re in the right places.”

Zappos philosophy about collaboration with vendors extends to B2B e-commerce and the information supply chain as well.  In the book, Zapppos managers state that “Traditionally in retail, information is hoarded, kept secret, and used as leverage against the vendors to get more out of them.  Retailers wouldn’t want a vendor to know how well they’re doing so they can demand more.  But if we created true transparency in our business, not only would they help us, they’d benefit as well…They’re able to see inventory levels, sales and profitability.  They can write suggested orders for our buyers to approve…In effect, they’re given the keys to the shop.”

I have to agree that we rarely see such high levels of trust and collaboration in the retail supply chain, which makes me wonder why more chains are not adopting similar principles.  Is there something unique about Zappos business model that enables them to offer vendors a fair profit and such high levels of transparency while other apparel and footwear retailers struggle to do the same?  What do you think?