Cost to Serve and Network Design

In 1987 Procter & Gamble and Wal-Mart Stores did business the way most American manufacturers and retailers did, by most accounts badly. P&G, the largest US consumer-goods maker, with sales of about $17 billion, sold through a sales force paid to push product and a calendar of trade promotions, temporary discounts that led retailers to buy far more than they could sell during the deal and then stop ordering. Walmart, with sales of about $16 billion in its 1988 fiscal year and on course to become P&G's largest customer, negotiated through buyers paid to push price (both figures reported). The two companies shared almost nothing. Each forecast demand on its own, each held safety stock against the other's surprises, and a share of each side's staff existed to dispute the other's invoices.

The story told in the case studies is that Lou Pritchett, P&G's vice-president of sales, arranged to meet Sam Walton on a canoe trip in Arkansas that summer and proposed that the two companies treat each other as partners rather than adversaries (reported). What followed was less romantic and more important. P&G moved a team drawn from sales, logistics, finance and information systems to Bentonville, initially a dozen or so people and later reportedly about 200. The companies linked their systems by electronic data interchange. Walmart gave P&G its sales and inventory data, starting with Pampers diapers, and P&G took responsibility for replenishing those products in Walmart's distribution centres, generating the orders itself. This was continuous replenishment, an early form of what became known as vendor-managed inventory: the forecast moved to the company that controlled production, and the order became a calculation rather than a negotiation. Invoicing and payment were automated, and the disputes fell away.

Pritchett's argument, as he later told it, was that both companies were spending heavily on activities that existed only because they did not trust each other (reported). The savings came from removing them: less inventory at both ends, fewer handling steps, fuller trucks, fewer stock-outs and fewer people reconciling paperwork. In the early 1990s P&G went further. It cut list prices on many brands and reduced trade deals and the number of price changes, a policy it called value pricing, and it helped sponsor the industry's Efficient Consumer Response initiative, whose 1993 study estimated that about $30 billion could be taken out of the US grocery chain (reported). The idea that the swings in a supplier's orders are partly created by its own pricing became mainstream supply-chain thinking.