Compete or Collaborate?
What we can learn from a trip to the Island of Siloville.
By: MonarchFx Staff
I commence this article with an invitation for you to join me on a journey to the fictional Island of Siloville. It will be an interesting visit because Siloville is populated by the most rugged and individualistic people on the planet. They grow their own food, sew their own clothes, and build their own homes. The Silovillian’s passion for self-reliance produces some unusual arrangements in almost every area of their lives but, for our visit, we are going to focus on the evolution of their transportation industry.
The Island of Siloville is served by two airlines, Silo Airways and SolitAir. Although these two airlines were founded in accordance with Siloville’s culture of self-reliance, their management teams quickly discovered their limitations. They realized, after a tragic accident, that their policy of having their own separate air traffic control departments was misguided. They also decided to discontinue their practice of manufacturing their own aircraft when they discovered that better, safer, and more efficient models were available from foreign manufacturers at a fraction of the cost. Finally, they abandoned their policy of having separate dedicated airports for each destination, when an investor pointed out how inefficient it was in the use of land, capital, and human resources.
By adopting strategies that focused on their core competencies, outsourcing non-core tasks to more efficient providers, and making common use of shared transportation infrastructure, Silo Airways and SolitAir were able to dramatically increase the service they offered to their customers and the financial returns they achieved for their shareholders. They still had trouble competing with foreign airlines. The problem was that the air travel market had become global. Despite their new found efficiency, the two airlines lacked the scale necessary to compete with the flag carriers of much larger nations. Before we look at the solution they adopted, we will take a look at our own transportation infrastructure here in the United States, to see if we have anything to learn from the experience in Siloville.
How Does the United States Supply Chain Infrastructure Compare?
You are probably thinking that we in the United States have too advanced and competitive an economy to repeat the mistakes of the Silovillians. Take a look at the table in Fig. 1.1, which shows the supply chain infrastructure of five of America’s largest multi-line retailers and brands.
In aggregate, this infrastructure amounts to 261 Distribution Centers (DC) with a total area of over 200 million square feet (about the same as 3,600 football fields) and, we believe, a market value in excess of $28 billion. If each of these DC had an average headcount of 300, the combined workforce would be over 75,000.
Think of all of that land, labor, and capital tied up in infrastructure that is dedicated, siloed, centralized and, in the near future, obsolete. It is becoming obsolete because retail sales are shifting to the online channel and this infrastructure lacks the scale, agility, and customer proximity to effectively handle the coming eCommerce storm.
Hurricane Warning – The Disruptive Effects of Amazon
Take a look at the two illustrations contained in Fig. 1.2. One is one of the most powerful and potentially disruptive ecosystems known to man. The other is a category 3 hurricane.
In fact, both systems work in a similar way. The hurricane is driven by an intense low pressure zone created by a rising column of warm moist air. Higher pressure air rushes in and upward, carrying a lot of the energy stored by a warm ocean and driving higher wind speeds and lower pressures in a self-reinforcing system.
The foundation of Amazon’s growth model is a realization that forward deployed inventory on a massive scale produces unit delivery costs that are lower, shipping distances that are shorter, and customer satisfaction that is higher. The real genius behind Amazon’s model was the insight that, by turning its supply chain infrastructure into a collaborative platform (“Fulfillment by Amazon”) and offering its functionality to other eCommerce sellers, it could scale so big, and so quickly, that no other online retailer could match its shipping speeds, service levels, and unit costs. Greater volumes drive lower costs, which drive lower prices, thereby attracting higher volumes. Another self-reinforcing system.
So What Happened to SiloAir and SolitAir?
It turns out that collaboration was the solution to the challenges facing SiloAir and SolitAir. Their boards’ did consider a merger as a strategy to increase scale, but they concluded that it would deprive each company of its unique culture and might attract the attention of Siloville’s antitrust authorities.
Instead, SiloAir and SolitAir each decided to collaborate with their larger competitors by joining airline alliances. SiloAir joined the One World Alliance and SolitAir joined the Star Alliance. In joining an alliance, each company discovered that they were able to retain their individual identities and cultures, while significantly increasing passenger volumes and load factors on their aircraft. Each airline had high service standards and aircraft types, with interiors so similar, that most passengers didn’t notice that they were traveling on a service operated by a different carrier.
In fact, by investing some of resulting efficiencies in lower prices, SiloAir and SolitAir discovered the phenomena of ‘demand creation’. Their lower pricing, combined with the significantly enhanced connectivity offered by their Alliance partners, really “opened up” the hitherto inaccessible Siloville to foreign tourists and business travelers in a way that provided major benefits, not just to the airlines, but to the economy as a whole.
Overcoming the Fallacy of “Post-Click Competition”
Shared collaborative use of supply chain infrastructure will lead to greater equipment utilization and higher profitability for retailers and brands. So, why are more retailers and brands not embracing it?
To be honest, we are not sure, but our discussions with retailers and brands suggest to us they continue to regard other retailers and brands as competitors, even after the customer has made a purchasing decision by clicking on the “buy box” of an item.
To us, this is a misunderstanding. An airline that has a number of committed passengers that could complete their journey more efficiently on your equipment is not a competitor; it is an opportunity. Collaboration allows them to redeploy their equipment on more efficient routes, while you receive higher utilization on yours. Both your customers and their customers enjoy lower prices. Both companies are likely to be more profitable as a result of using their equipment more efficiently.
Some retailers and brands have expressed reservations about “brand dilution” arising from collaboration but, in most cases, this is unlikely to be a factor. Airline travel is a far more personalized service than package delivery. If a committed Delta Airlines traveler has no problem completing the final leg of their journey to Bangkok on Thai Airlines, is it really likely that the purchaser of a pair of Nike running shoes will be concerned that at some unseen point on their supply chain journey, they may have been commingled with a pair of Reeboks?
Traditional Retailers and Brands Need to Embrace Collaboration if they are to Succeed in eCommerce
As United States retail sales move to the eCommerce channel, traditional retailers and brands need to understand the enormity of the challenge they face. Amazon has invested over $15 billion in local automated fulfillment capacity and now has at least one full-scale fulfillment center located an average of just 57 miles from each one of the top 40 United States Metropolitan Statistical Areas (MSA). Those top 40 MSA are home to 164 million (or 52%) of America’s highest spending, fastest growing, densest urban located consumers.
The customer proximity created this local fulfillment infrastructure, creating significant reductions in the average time, distance, and costs that Amazon incurs in shipping its products, versus the costs that other online retailers and brands face in shipping theirs. Amazon has doubled down on these cost advantages by creating the Fulfillment by Amazon platform, allowing other eCommerce retailers and brands to use this infrastructure to fulfill their orders far more cheaply and effectively than they could hope to do on their own.
Higher volumes create lower costs which attracts more 3rd party volumes in the self-reinforcing, hurricane-like, business model that we described earlier. The chart in Fig. 1.3 shows the size and growth rate of Amazon’s worldwide Gross Merchandize Value (GMV) compared to the combined online sales of all five of the multi-line retailers (Walmart, Costco, Target, Macy’s, and Kohl’s) discussed above.
On a combined basis, the multi-line retailers have grown their eCommerce revenues by 20% per annum during this period, but this was from a relatively small base. Although, eCommerce revenues are growing much faster than their traditional sales, by 2015 they still represented just 4.5% of total sales.
Amazon, on the other hand, focuses exclusively on eCommerce sales and it does them very well. From 2013 to 2015, Amazon grew its GMV (a measure that includes both its own sales and the sales it fulfills for 3rd parties) by just over 43% per annum. This was over 2 times the growth rate achieved by the five multi-line retailers and brands so that Amazon’s sales, which were 4 times the size of the multi-lines in 2013, rose to 5.6 times their size in 2015.
eCommerce Sellers Need to Join an Alliance
Attempting to catch up with a competitor who is running twice as fast as you is a lost cause. Amazon’s fulfillment infrastructure took over 10 years and cost over $15 billion to build. No single retailer has the capital to build a competing network and no single retailer would have the volumes to operate it efficiently even it did. As we have seen, it is only by attracting significant third party volumes (approximately 50% of total sales in 2015) that Amazon is able to achieve the impressive scale economies that it enjoys.
eCommerce sellers that wish to preserve their brands and market share, achieving real growth in eCommerce sales and profitability should follow the examples of SiloAir and SolitAir, and even Amazon itself, and join a collaborative alliance.
eCommerce Sellers Should Join The MonarchFx Alliance
There are a number of critical success factors associated with building a successful collaborative logistics platform. Some of the key factors are:
- A long term vision
- An absolute commitment to integrity
- An independent management team, trusted and respected by all partners
- Shared commitment to common standards of customer service
- Deep supply chain expertise
- State of the art systems that are very scalable
- Significant capital resources
In 2016, a number of America’s largest 3rd party logistics companies got together with their leading supply chain software company and largest final mile delivery company under the leadership of Jim Tompkins, CEO, Tompkins International (an American leading supply chain consultancy) to form The MonarchFx Alliance.
The founders of The MonarchFx Alliance are logistics experts with deep experience in America’s retail supply chain. The MonarchFx Alliance was formed because we witness daily the difficulties that our retail clients are having in utilizing or adapting traditional retail supply chain infrastructure to the very different and demanding requirements of modern eCommerce.
The basic system and infrastructure of The MonarchFx Alliance is set out in Fig. 1.4 below:
The essential idea behind MonarchFx is a small number of America’s largest and best 3rd party logistics companies collaborating to operate a network of forward deployed, multi-tenanted, and highly automated fulfillment centers on a collaborative basis on behalf of some of America’s largest eCommerce retailers and brands. The combined volumes for all of these sellers are aggregated to achieve unbeatable final mile density, which is critical to reducing unit delivery costs.
We are convinced that The MonarchFx Alliance collaborative fulfillment platform will scale much faster than almost any dedicated retail supply chain and will, quickly deliver customer service levels and unit delivery costs that few, if any, individual systems can match.
The pilots, passengers, and aircrew of SiloAir and SolitAir were fictional. American retail companies, the customers who buy from them, and the employee’s whose livelihoods depend upon their survival are real and the threats caused by the channel shift to eCommerce and the increasing competition of Amazon are very real indeed. 2016 witnessed earnings downgrades from Macy’s, Kohl’s, Nordstrom, and many other retailers and brands and the bankruptcies of Sports Authority and Aeropostale. In each case the company’s business model and supply chain were unable to adapt to the challenges of the online sales channel.
In fact there is an expression that we at The MonarchFx Alliance were initially very fond of:
“If you want to grow incrementally, be competitive. If you want to grow exponentially, be collaborative.”
Although we still like this expression, we are beginning to wonder whether it is entirely accurate. In many cases, collaboration is not just a route to achieving higher growth rates; it is a matter of survival.