A VC in Vacationland

The 'New Normal' is now the 'No Normal' in Supply Chains

Supply chain disruptions are nothing new. We've had many in the past and will have many more in the future. But this time may be different. Why?

Historic supply chain disruptions were often caused by single, localized events.  Take the federal deregulation of the U.S. transportation industry in the 1970s and 1980s. Carriers were freed from charging freight rates based on regulated tariffs controlled and monitored by government bureaucrats. The result of deregulation was that shipping rates fell dramatically, enabling carriers (and shippers) to move goods over greater distances at lower rates. Producers, distributors, and retailers sought to expand markets in new regions, set up distribution operations, and serve new customers. Hub & spoke logistics networks emerged, with plant-based warehouses serving a distributed network of regional facilities close to customers. Absent major new shocks to the system, this became the defacto supply chain strategy for many companies until the 2000s. A New Normal for U.S. supply chains was created and lasted for many decades. 

Of course, we are oversimplifying what actually happened. There were many innovative changes that happened inside this basic strategy and continue to happen. But e-commerce, coupled with globalization and political uncertainties has created a new set of disruptions that will continue to impact supply chains for many decades. And it is likely we will never return to a New Normal in supply chains as a result. Why is today different? 

The simple answer is that supply chain participants have less control over their shipping environment than ever before. When supply chains were primarily U.S.-focused, shippers and carriers could interact in a regulatory world that was well-known and understood. Adding in trade among hundreds of countries, which began in earnest in the late 1990s and early 2000s, has opened supply chains to many more unknowns-different regulatory schemes, political conflict, impacts of a changing climate, and wars, among other factors.

Coupled with the rapid growth of e-commerce and you have another disruptor altering carefully plotted supply chain strategies. Consumer gratification, thanks in part to the Amazons' and Alibabas' of the world, has morphed to become 'get it when and how I want it'. Instead of the old paradigm--the manufacturer makes a product, and sells it to a distributor or retailer, who puts it in a store for the consumer to pick it out and up--designing supply chains has become the wild, wild west in terms of satisfying consumer needs.

In addition to showing up and shopping at a local store, consumers now can get their purchases from many participants in supply chains via drop ship options--the product could be sent directly from a supplier in China, from a U.S. plant, or via a distributor, a regional warehouse, or even from the local or distant store via a courier.

All this has led to an increased focus on supply chain resilience--meaning that one may need more rather than fewer options to satisfy consumer demand. And it goes well beyond sourcing strategies. Political conflicts, wars, climate change, and concerns about human exploitation are all creating disruptions in established parts of supply chains--product sources, ports, and carriers are not always able to (or should not) handle pre-determined shipment routings. 

We likely will never see another New Normal in supply chains. Perhaps as the title says, the New Normal is now the No Normal. With hundreds of thousands of independent but interdependent supply chain players making the global logistics systems work, all will have to change the way they do business. And if that is a present and future reality, then we will need a whole new way of looking at supply chain strategies--ones that can have the flexibility to change quickly as global events affect pre-planned operations.

But that is a subject for a future Blog--stay tuned.

Supply Chains--Capitalism's Greatest Success Story and Biggest Problem Going Forward

Call me a curmudgeon, but I'm tired of the 'misery du jour' surrounding current supply chain problems.

Supply chains have become the whipping boy of the global press. It's hard to not find a daily derogatory story about how Christmas will be ruined, carmakers can't get enough semiconductors to finish/sell vehicles, or the number of ships waiting to unload at LA/LB will cause chaos in the US. Wait a minute. Supply chains are working so well that store shelves remain mostly full, Amazon Prime packages still arrive (perhaps a day late) and one can still get their Big Mac every day at thousands of McDonald's across the globe. Enough chaos nonsense already...

Why are supply chains one of Capitalism's greatest success stories?

We had a non-supply chain-oriented friend ask who controls the global supply chains? Is it the United Nations? Some other regulatory body? Of course not. 

Supply chains are one of capitalism's best success stories. Getting a product from a manufacturer to a consumer involves thousands of totally independent players doing their own thing. Think of bringing a product from China to the US:

• Local Chinese suppliers ship to a local manufacturer
• The manufacturer makes the product 
• A container is loaded, perhaps for more than one manufacturer
• Local drayage companies moved the container to a local port
• Freight forwarder arranges ocean shipping with carriers
• Customs broker arranges custom clearance in receiving country
• Port operator loads container on the ship
• Container shipping company moves container to US port
• Port unloads and drays container to a railhead/local logistic hub
• Over the road/rail flows from the hub to distributors or retailers
• Retailer moves the product to the consumer via e-commerce or pickup

As any supply chain professional can tell you even the above movement complexity is a gross simplification of what actually happens. And this is only a single shipment. Millions of such moves are initiated and are taking place on a daily basis across the globe.

All these logistics providers are generally separately owned and operated. Supply chain management is a fragmented business, with numerous small and large companies all performing specific tasks to make a move happen. Of course, some global players like Maersk are looking to manage all aspects of movements for shippers, but when you look under the hood, they are still dealing with many local, forwarders, brokers, drayage companies, etc., to make a move happen.

So everyone please relax for a bit. We definitely will be missing holiday presents, but we still have plenty to eat (well, most of us), thanks to our well-run supply chains. Perhaps it's the year to give experiences and/or services to our kids and friends as opposed to a product. With all the products stuck in the US to China supply chain, there will be plenty of bargains available in January and February to satisfy our need for physical possessions.

Why are supply chains one of capitalism's biggest problems going forward?

We discussed the emerging evolution of supply chains in a previous Blog--Ship Anything From Anywhere. The basic premise is that our current supply chain technologies allow us to create even more instant gratification options--basically getting a product or service when we want it, from where we want it, and how we want it, regardless of the environmental and social costs.

The poster child for this is Amazon, currently building out over 450 processing/delivery sites to handle both the holiday shipping crunch as well as position the company for the new world of 'get my stuff (nearly) instantly'. All this supply chain development is occurring in the midst of one of the greatest crises civilization is facing--global warming. We know some of you consider this a fallacy, but the reality is that as we add more single shipments to supply chains we are increasing carbon emissions with little consideration for the consequences. Technologies are emerging, such as electric delivery vehicles, which will reduce some of the impacts, but we also need to consider how we will make the electricity to charge all these vehicles.

We are not going to get all preachy about the emerging issues around how supply chains will exacerbate global traffic congestion, create new environmental externalities and spawn unseen impacts on quality of life going forward. We would rather focus on solutions than on yapping about the problems. The trick will be to get millions of independent supply chain partners to act in ways to collectively mitigate these issues, something that they have never had to do in the past. It's going to be an interesting next few decades.

 

What are the Upsides & Downsides of the Coming 4th Q 2021 Supply Chain Armageddon?

We hope we don't get labeled as curmudgeons as a result of this post. We are trying to see the positives and negatives of the ongoing supply chain crises facing the world.  Supply chains have not been top of mind for anybody(but supply chain professionals) for years. Now it's top of mind for most everyone and will remain that way for a long time. And, truthfully, we hope we are wrong about the depth and length of the problems but we don't think so...

We know it's coming. Manufacturing problems in Asia, too few containers & ships, overcrowded ports, lack of landside freight capacity in the US, Asia & Europe among other factors point to a further supply chain meltdown over the next three months.

There's not much many of us can do about the continuing problems with supply chains. And it's not just one issue, it's many that are simultaneously interacting to produce the current crisis. If you are a huge global shipper like Ikea, you can charter container ships to move your boxes, but good luck getting them unloaded and transported inland with any decent transit times. For everyone else, you better buy holiday gifts early, if you even find any now.

Let's focus on a few upsides first.

From an infrastructure perspective, the current problems in global supply chains will put a fine focus on an area that has historically suffered from underinvestment, both in infrastructure and in technology. Expect to see governments ( we are thinking about you, Egypt, who should have widened the Suez Canal decades ago), European countries who need to expand rail capacity for inland freight (the roads are already overloaded), Asia to build out landside transportation from plants to ports and North America (just about all freight infrastructure upgrades are past due, also by decades). Will governments and private companies step up to the challenge? We'll see. We are not holding our breath. We are already seeing missives from the freight PR lobby that the supply chain crisis is due to over-ordering/buying by companies and consumers, not because carriers, ports, et.al. don't have enough capacity. There's some truth in this argument, but the word 'some' is operative.

From a technology perspective, many carriers, shippers, ports, and affiliated players (forwarders, etc.) are on a supply chain technology buying binge. It remains to be seen how much of this technology will positively contribute to reducing backlogs in supply chain operations, but it's better than doing nothing. Why are we skeptical of these technologies as a solution? Often, these new technologies will focus on optimizing a single supply chain player's operations, not across the complex global supply chains that they participate in. There are definitely supply chain technology solutions that begin to optimize operations across multiple segments of the supply chain, but their adoption is the exception rather than the rule.

How about the downsides?

It's not going to get any better for global supply chains any time soon. Why? it's not just a few problems it's many and some, like COVID Delta (and newly emerging viruses), are outside the control of supply chain professionals. It will take years to restore any semblance of normalcy in supply chains as many of these current issues cannot be attacked simultaneously--we can build a lot more containers really fast, but it will take years to launch new container ships to move them.

Consumers will discover the wonderful world of substitute products. Whole Foods and other supermarkets have bare shelves in every aisle, different ones every week. Even Amazon can't figure out how to correct supply chain problems. When's the last time you actually got an Amazon Prime order in two days? One of ours came today (Reid Hoffman's new book, Masters of Scale--highly recommended), the first one in months...and the last for a while, looking at estimated delivery dates on other orders. No Ritz crackers or Oreos for months? Mondelez workers are on extended strike, another twist to supply chain problems. Late July has some good substitutes, but their shelves are now empty as well from substitute buying.

Companies will have to pare SKUs, increase prices and improve inventory positioning. We have lived through an era where SKU proliferation has created much more supply chain complexity, stuffing supply chains with 'new' products, ones that have minimal tweaks to the existing products but creating more stuff to move through the supply chain. We have also lived through a time when distribution center consolidation has led to fewer inventories sources nearer consumers. The growth of omnichannel shipping and next-day/same-day deliveries has companies scrambling to rent/build more warehouses closer to prime markets. It's going to be expensive for companies to make these transitions, require new facilities and technology, and keep the CFO up at night deciding how to pay for it all. And oh, by the way, product prices will be going up to pay for it all.

So what's the average consumer to do in this wonderful world of supply chain crises? Grin and bear it? That's the reality for most. It's hard to find other supply chains to replace the ones that feed, cloth, and provide us with all the other products in our lives. Being creative in shopping is another approach. Wise supply chain gurus have always told us that Walmart is the least shorted of all the major chains, so showing up at 7 AM at a Walmart store near you may yield some of the products missing from your other retailers. Finally, it may be time to actually look at ways to reduce our overconsumption and do more with less product. Not an answer a lot of consumers want to hear, but when the shelf is bare, the shelf is bare.

Looking forward to an interesting holiday season...

 

 

 

Middleware Assumes an Increased Importance in Supply Chain Management

Let's be clear--middleware (or iPaaS, if you prefer the more modern term for platform integration) has been a key part of supply chain management for decades. B2B communications surrounding orders, freight bills, shipment status, invoices, etc. across the supply chain between retailers, distributors, manufacturers, suppliers, and others have been conducted using Electronic Data Interchange (EDI) since the 1970s. Recently, some of the more progressive retailers, such as Walmart and Target have begun using proprietary communications protocols, or APIs (Application Programming Interfaces) as their basic communications standards, requiring other supply chain partners to use them for all communications. B2B communications technologies based on streaming data tools are also emerging, allowing supply chain partners real-time access to each other's information, creating more opportunities to enhance supply chain efficiencies. But the B2B communications revolution is a topic for a future Blog.

So where, you say, is middleware needed in other areas of supply chain management? Let's start with automation. Our plants, distribution centers, trucks, yards are becoming hives of new technologies, often from many different vendors. Take a warehouse for example--you can have automated forklifts, VR technologies, ASRS systems, picking robots all with their own control systems, all wanted to access the order management (OM) and warehouse management servers (WMS) at the same time. The reality is that allowing one system to immediately access the OM or WMS at the expense of others with a more critical (or more efficient) request is not good facility management. 

Enter multi-automation technology optimization solutions, such as Seyo (in full disclosure, an SCV portfolio company). Founded by entrepreneurs with PhDs in computer science, Seyo can manage a fleet in a warehouse, or out in a remote robotic farm just as effectively. On-the-fly optimizations, by combining data at the edge with the Seyo Management System, missions and paths can be recalculated every time a robot changes its current state eliminating congestion and protecting the system from deadlock.

And then there is the automation operator problem. All those different technologies require sophisticated and constant operator training as machine upgrades are commonly done via the Cloud, meaning an operator might show up in the morning and find a significant change has been made in the control system of their machine. And what if an operator is sick that day but the machine is a critical part of an assembly process? Are there other operators trained in the technology that can substitute? Note: this is a serious issue in aircraft manufacturing, where regulatory agencies require all parts to be produced by fully trained operators.

Enter Covalent Networks (yes, another SCV portfolio company). Covalent is a cloud-based middleware software as a service solution that works on any internet-connected device, allowing for training, evaluation, and remediation processes to occur in the flow of work. It's easy for trainees, trainers, and supervisors to complete their action items in real-time and for leaders to match critical worker-competency data with broader operational data sets. Historically, managing in-facility training on automation was often handled by Excel spreadsheets--not the best way to manage complex training data across multiple machines and people. Launching a new procedural change that requires re-training? Deploy that training instantly to the workers that need it. Need to forecast your workforce's capability to meet next month's customer orders? Run an automatic analysis and identify gaps.

All this can be done in a few minutes, as opposed to running around trying to find that Excel spreadsheet and decide who may or not be capable of running the latest version of the automated equipment.

And now onto emerging issues in supply chain management that involve the use of blockchain technologies to manage B2B communications across the supply chain. Some innovative Tier 1 suppliers, looking to create a fully verified chain of custody with their Tier 2,3 4 suppliers are creating private blockchain solutions, especially as manufacturers and retailers want proof that the suppliers are not using slave labor, etc. Since widely acceptable blockchain standards do not yet exist ( and may never), a manufacturer seeking to connect with numerous private supplier blockchains, often with different cryptocurrencies needs a translation middleware to make sure all supply chain partners can speak to each other in their own languages.

Enter Finboot (yes, another portfolio company). Finboot is the SaaS company behind MARCO, the enterprise-grade suite of blockchain applications and middleware solutions for value and supply chains. Finboot facilitates the adoption of  Distributed Ledger Technology (DLT) and Blockchain technologies into daily business operations, generating ecosystems based on trust, collaboration, and transparency-- focusing on solving real business problems that quickly generate a return on investment. In particular, their technology allows companies to manage private blockchains with varying currencies and standards across a wide variety of supply chain partners. 

And what about NFTs? Those NFTs (non-fungible token, read more here), currently popular with the art, media, and sports world, could prove useful in the tracking of individual items along the global supply chain from an authenticity and verification standpoint. Is it just hype? Hard to tell at present, but watch closely for any clear use cases that emerge with associated business value propositions.

All in all, middleware is becoming an even more crucial tool in managing our increasingly complex supply chains. Look for lots more innovation in this space going forward. 

Ship Anything from Anywhere--Emerging Omnichannel Supply Chain Strategies

There is an emerging strategy in supply chain networks--ship anything from anywhere. This is not a new trend but has gained new credence in the COVID time. Companies ran short of products or supplies and looked deep into their supply chains for alternative sources and shipping options. Once these new sourcing linkages are built across supply chains, there's no going back. Supply chain partners across all echelons need to prepare for a future where just having products available to ship in the part of the supply chain you directly control will not be a winning strategy.

The concept of drop ship--the ability to source/ship a product or materials from various partners in a supply chain network--underlies the ship anything from anywhere strategy. Drop ship is not a new concept but became a necessity for many companies during COVID when they ran short of the ability to quickly satisfy consumer's (or manufacturing) demand from traditional sources. The usual suppliers ran short of materials or products and companies had to seek new sources, often companies with whom they had not done business in the past. And to meet demands, either the consumer of manufacturing, companies often asked whether these new sources could ship directly to a plant or consumer, not using traditional channels (for example supplier to distributor to company warehouse to consumer).

Omnichannel delivery strategies have also contributed to the ship anything from anywhere paradigm. Retailers, for example, started to realize that they could drop ship to the consumer directly from their stores, instead of from their warehouse operations. Of course, one has to evaluate the cost to serve from these alternatives, but it is often cheaper and faster to use a variety of options to meet demands, rather than to rely on traditional 'linear' supply chains (where companies move products from suppliers or plants to their own distribution centers the to stores and the consumer).

Difficulties in forecasting are just one of the issues that arise in implementing a ship anything from anywhere, or omnichannel, strategy. How do you plan demand when the consumer has so many alternative paths to your product--stores, company websites, marketplaces to name a few? The new paradigm will require upgraded supply chain decision software that has the ability to rapidly decide which product source is the best one to meet customer needs. Besides traditional cost & service, additional factors, such as the ability of a manufacturer or other supplier in the supply chain to manage a local delivery, especially one requiring special handling.

Will it all go back to 'normal' when we get to the other side of the COVID economy? The simple answer is no--omnichannel supply chain strategies powered by drop ship are here to stay. All supply chain participants need to begin to modify their operations to conform to the new future state. Companies wishing to have their manufacturers or suppliers ship directly to customers may have to provide a range of digital commerce support capabilities that are not typically used by up-channel partners, including:

• listing tools
• commerce analytics
• product information management
• digital asset management
• digital image capture
• returns management
• product marketing

It is going to be a very interesting world in supply chains over the next decade as we witness all these changes.

 

Are we about to witness the death of free shipping?

I've seen a number of articles lately predicting an end to free product shipping, perhaps as early as this year for some retailers.

The general argument is that rapidly rising freight labor costs, especially among the parcel carriers (UPS, USPS, FedEx, DHL), are already resulting in at least another 5% rate increase in January 2019 (with more likely to come). The ability of shippers to absorb new freight rate increases in landed product prices is becoming increasingly constrained by rising manufacturing costs (due to tariffs and higher wages in developing countries). Will the latest rate increases be the tipping point?

It is too early to predict the end of free shipping.  Much depends on the ability of carriers to adopt new technologies and adapt to changing inventory positioning strategies by shippers. Let's be honest--the trend of consumer convenience and instant gratification is not going away. Retailers and other product companies are dependent on parcel companies to get their products to customers when they want them or lose market share. Amazon is building their own delivery fleets. They will siphon off the best freight for their network, leaving the more difficult deliveries (rural, inner city) to parcel carriers or outsourced contractors. This will not improve the cost situation for parcel carriers, leading perhaps to further rate increases as freight quality diminishes.

From a carrier perspective, incorporating better real-time information into supply chain planning and execution decisions will provide some relief, but such changes to legacy technologies can take years to populate across global networks. Finding new lift capabilities, such as surplus belly air cargo routes is another option, especially to expand e-commerce deliveries into less developed parts of the world. Both these options are, again, multi-year solutions.

On the shipper side, the trend to forward position more inventory, whether in brick & mortar stores or in small near-urban warehouses, will satisfy consumer desires, but at a higher cost to shippers. Retailers and manufacturers have spent the last three or so decades have been spent consolidating warehouses and inventory in large regional facilities, and are generally not well equipped to handle e-commerce shipping. Shippers now face the double-cost challenges of expanded inventory and local warehouses along with rising freight costs. Robotics may help some in the new facilities, but it is not a panacea.

Can these consumer desire/shipper cost conundrums resolve themselves? We'll see, but the retailer, manufacturer and freight industries need to undergo some radical transformations if we are to maintain free shipping without significant product cost increases. Stay tuned...

Supply Chain Innovators: Blue Apron dis-intermediates food supply chain

Tasty Food Abundance in Healthy Europe (Photo credit: epSos.de)

Blue Apron, a Brooklyn, N.Y..-based fresh food and dinner recipe subscription service, has raised $5 million in Series B funding. Bessemer Venture Partners led the round, and fellow return backers like First Round Capital. www.blueapron.com  

My son and his wife are a big user of Blue Apron, even though he lives in the take-out capital of the world--New York City. Why? They are both professionals, with little time to shop and prep dinner. They gets just the right amount of fresh and healthy food for his family which can be converted into a meal in about 30-45 minutes--approximately the same amount of time it takes to order and receive delivery of the take out food. And it is served at its peak of freshness, not continuing to cook in the steam of a take out container.

Thanks to Blue Apron for revolutionizing food chain logistics and feeding my family high quality meals at reasonable prices.

Supply Chain Strategy: Big Data or Big Bust?

Buzzword Bingo: Big Data = Collection of large and complex data sets (Photo credit: planeta)

Big Data frenzy is sweeping the supply chain world. Numerous article tout the 'importance' of big data in making optimal planning, execution and investment decisions. Well, maybe...

First, a few thoughts on how Big Data could be helpful. Using downstream data on consumer insights, for example, could provide valuable insights into emerging consumer demand and enhance forecasting. Consumer feedback on carriers and deliveries can be used to improve outbound execution. Finally, monitoring Twitter or Facebook feeds can catch consumer dissatisfaction with deliveries and provide a forum for addressing the issues.

But Big Data accumulation and usage may be problematic. First, Big Data has many owners beyond your company--shipper's own the purchase orders, but carriers and many other third parties own much of the in transit/delivery data. Big Data owners are increasingly charging for data access, or limiting access due to consumer privacy concerns. Finally, linking together various data sources to get a coherent view of deliveries processes is a complex and expensive process.

So when your boss, after having read a glowing article on using Big Data to solve logistics problems, shows up in your office and asks what you are doing to integrate Big Data into your execution processes, be sure you have at least done your homework on what data may be useful and where you can get it. 
Your supply chain software provider, who is probably already evaluating how to add Big Data to their applications is a good place to start. There are numerous articles I have read recently on the subject of using Big Data to improve supply chain decision making, but none worth noting here. Stay tuned...I continue to look.

Supply Chain Strategy: Slow Pay--Suppliers as Capital Lenders??

Cincinnati's Procter & Gamble is one of Ohio's largest companies in terms of revenue. (Photo credit: Wikipedia)

P&G announced today that they would be extending payment terms for suppliers from 45 to 75 days. The goal is to raise $2 billion per year for new capital expenditures. JC Penny and Walmart, among others, have already implemented slow-pay programs to save cash.

Two questions: Is it fair? Is this a strategy that will further confuse payment terms in supply chains?

For the fair perspective, what's fair? Oligopolists, meaning global consumer products companies with lots of desired brands in this case, have a lot of market power,especially with smaller suppliers. These suppliers will have to approach their already leery bankers for an increase in their AR lines, or seek other financing options to cover the extended float. Fair? It's all in the eyes of the beholder, but those who have the gold makes the rules. It does seem a bit cheesy on the part of P&G who can probably borrow money for less than 5%, compared to twice that interest rate for an AR loan for their suppliers.

Is this the start of a new trend in the supply chain financing? Manufacturers and retailers have historically extended payment terms in times of economic stress. This move feels different. If the P&G move sticks, and there is no reason to think it will not, many others will follow, opening a whole new credit source for financing supply chain transactions. If the move is transitory, which it has been in the past, due to supplier pressure, then the supply chain financing options will return to some semblance of the past. P&G and others will work to make this stick. Where else can you get $2 billion in free cash without any work? Genius move on the part of the finance guys.

We'll see if this happens, but it does not look good for downstream providers, including software and hardware suppliers.

Supply Chain Strategy: WTF are 3-D supply chains?

English: The FedEx Institute of Technology is a major research contributor in the areas of Supply Chain Management, robotics, and intelligent systems. (Photo credit: Wikipedia)

Huffington Post recently published a Blog extolling the virtues of "3-D supply chains" (whatever they might be) and how the technology could revolutionize the global economy. The authors bemoan the fact that US companies use execution based software to manage their supply chains, but lack the strong operational feedback models that Toyota uses to drive flexibility in operations.

Well, pardon me, but the authors are pretty ignorant of the transformations going on in North American supply chain management over the last decade. FedEx and UPS use real time routing systems to alter delivery routes as requirements change during the day. Descartes' Global Logistics Network connects tens of thousands of suppliers, carriers, manufacturers and retailers, allowing real time visibility and management of shipments pending and in transit. What about companies like Alibaba and Panjiva, who give any company access to millions of global suppliers--instantly? I could go on but you get the point. A little internet searching can accomplish a lot of "3-D supply chain" objectives.

They then carry the argument to more absurd height, speaking about 3-D supply chains allowing all businesses having a "competitive relationship with like businesses under fair conditions, and not simply by size" and that a "cooperative relationship will arise between a business and its nearby competitors". Huh? Is this like not knowing you are a dog on the internet? I just don't get it. 

The authors would be better served to learn more about supply chains today than is spouting academic speak about "how things should be" in some perfect world only they have the eyeglasses to see.

Supply Chain Innovators: Amazon Redefines Warehouse Operations with Kiva

Image via CrunchBase

Many people have asked me why Amazon spent so much money to buy KIva Systems.  I usually give them a short response, focusing on the ability of Kiva to reinvent pick and pack operations in their warehouses. And I usually get a blank stare as most people are not that versed in the history of warehouse automation in the United States.

Here is a well written piece by Steve Banker in ARC's Logistics Viewpoints that explains the rationale for the purchase in detail (thanks to my buddy Dan Dershem for pointing it out):

The New Amazon Distribution Model 

 

Recently, Kiva Systems told its existing clients how its acquisition by Amazon would affect them. But the news also revealed something about Amazon's distribution strategy.

 So here is the news: Kiva will not be selling any new systems to new customers for the next one and a half to two years. Instead, Amazon will be filling its new one million square foot distribution centers (DCs) with Kiva robots. In its second quarter financial statement, Amazon said that it had opened 6 DCs this year, with 12 more scheduled for the remainder of 2012 (17 were built last year).

 I wrote a strategic report in 2009 titled "Warehouse 2025" (available to ARC clients only) that looked at the economics of the new generation of distribution robots.

 Amazon appears to practice mainly pick-to-cart. Each cart has multiple totes. Its warehouses have mezzanine levels; workers often have to push their carts onto a lift to change levels. Once a tote has been completely picked, it is placed on a conveyor and transported to pack stations. Amazon's labor goals are roughly 160 picks per hour.

 In contrast, Kiva Systems leads to higher productivity per worker. Workers work at combination pick/pack stations and the Kiva bots deliver the inventory to them to pick. The pick rate will depend on what is picked - if it is small items picked in multiple quantities, you might go as high as 1,500 items per hour; apparel is closer to 200 items per hour. In my report, I used 600 line items per hour as an average for Kiva empowered workers.

 So what would this mean in terms of workers? My initial estimate was that Amazon would employ 45 percent fewer workers per DC. But one of the contacts I interviewed for my strategic report told me that number was too high; his warehouse employs 30-40 percent fewer people by using Kiva.

 If you conduct a Google search on "Amazon distribution center," you come across announcements over the past year for DCs in Virginia, New Jersey, and South Carolina. According to these articles, warehouses costing roughly $50-65 million will employ 1,500 to 2,000 workers.

 But then I came across an article about a new Indiana DC. This DC is costing $150 million and the company is only promising 1,000 new workers. Could this be one of the new warehouses that will be using Kiva? The employment numbers seem to add up. This DC will employ at least one third fewer workers.

 The total cost of the new Indiana warehouse also seems roughly right. Kiva is sold as a system - robots plus their warehouse control system software. But if you take the total cost of the system and divide it by the number of robots, I estimate that the cost per robot is about $20,000-$30,000. There will be about 6 to 9 robots serving each station. With a two shift operation, and the understanding that the great majority of workers will now work pack stations, you can see how the Kiva robots would add $40 million to the cost of the new DC even if Amazon buys the robots for half of the purchase price of the general market.

 Let's tackle that last assumption, that Amazon can buy the robots for half price. Part of that is based on the fact that Kiva Systems sells premium-priced, high-margin product, which Amazon will now buy at cost. But I also see falling unit costs based on a huge increase in production volume. Word on the street is that Kiva did about $100 million in revenues last year. Based on my back of the envelope calculation, one of Amazon's new DCs will require more than 80 percent of Kiva's total production from all of last year. If even half of the un-built DCs scheduled to come online this year use Kiva robots, we are looking at 5X production ramp.

 Again, doing a little rough math, and depending on what you think a fully loaded warehouse worker costs and exactly how many workers become unnecessary, Kiva warehouses could save Amazon more than $20-35 million in wages and benefits per warehouse per year. If it implements Kiva at 6 DCs this year, and 20 more over the following two years, the company will get its payback for the Kiva investment.

 There are some other advantages. Without buying Kiva and ramping production volumes, Amazon could never implement Kiva across its network of new DCs. Further, the company's backlog prevents other e-fulfillment competitors (that are not Kiva's existing clients) from copying what it is doing for at least a year and a half.

 Finally, as Adrian Gonzalez pointed out in a recent posting, Amazon appears to be on a quest for same day deliveries. Kiva robots provide a blend of automation and flexibility that traditional forms of heavy automation cannot match.

 What at first glance looked like an absurdly high acquisition price for Kiva Systems becomes completely rational. But the success of this investment will depend on how quickly and successfully Amazon can ramp the production.