Inventory Management: Amazon

Executive Summary

The purpose of this case review was to study the case titled ‘Amazon.com’s Inventory Management’ written by Ms. Purnima Pillai and analyzes three different topics of discussion and presents an analytical prescription for each of them. Research on the case study is based on analyzing the pre-required questions and studying various articles, seminar papers, Magazines and Case Study’s with an overall view about E-Retailer’s Inventory Management.

The major findings indicate that Amazon developed gradually over adopting the correct strategy in order to manage its Inventory. Moreover, Amazon’s decisions in maintaining its inventory have been fruitful over time.

It was quite apparent from the analyses that Amazon had taken every move quite deliberately in regards to managing its Inventory. While it was also a clear indication that company advanced to greater heights after taking up a decision in selling its various competitors products in line with its own.

“Stack Them High, Let ’em Fly”

The right strategy for the Inventory Management is the most important factor behind any e-tailer’s success. Slackness in managing the Inventory correctly is not only a planning issue but also relates to performance having a significant impact on the company. A company’s right strategy includes ensuring that the products are available to the customer when they are requested with a high inventory turnover which if not maintained may lead to dismay to the customers and sales may be affected. Moreover, an overstock leads to high inventory loss, loss in profit markdowns and high cost of goods sold. Thus, implementing the correct strategy for a company is utmost important

Analysis & Diagnosis of the right strategy for Inventory Management

1.1 The Traditional Approach / Warehouse Approach

In the initial stage Amazon started its operations without stocking any goods but soon realized the need of it and stocked every possible product under its company owned warehouses which led the company to face huge losses and suffered inventory management crisis.

1.1.1 Pros of a Warehouse Approach;

  • Help in fulfilling all the customer demands.
  • Customer is never disappointed as the product is never out of stock and delivery matched on time.
  • According to (Bailey & Rabinovich 2006, pp.258-271), as the merchandise gains popularity among the market, internet retailers support to hold those products under their own warehouses and (Bailey & Rabinovich 2006, pp.258-271) studied with a hypothesis on Amazon.com and Barnesandnoble.com which fetched them a positive result for POPULAR products at 0.05-level coefficient who stocked in the POPULAR products (Appendix 1).

1.1.2 Cons of a Warehouse Approach:

  • It leads to high Inventory Losses
  • It may lead to a service level imbalance.
  • Short Term Demand products may lead to huge inventory losses if stocked high
  • Constant changes in the trends and fashion, may lead to losses if such products stocked high.

1.2 The Drop Shipment Approach

Amazon adopted the Drop Shipment Approach after a short period of time when the company realized that it required more fundamental approach in order to curtail the inventory cost.

Drop Shipment

Drop Shipment is an arrangement wherein the retailers usually forward the orders received from the customers to the manufacturers or distributors. Manufacturers then directly fulfill the customer’s order from their own inventory.

Market opportunities that may affect considering Drop Shipment Approach are:

1.2.1 Product Variety

It has been documented that wider range of products offered by the company increases company’s demand rate and gives a fundamental rise in the inventory handling costs. We expect the Drop Shipment Approach to fetch fruitful results on economies of scale as the retailer depends on the wholesaler for the goods and on the contrary, the wholesaler supplies goods to many vendors, thus, leveraging the inventory supply. But, if the customer is to be supplied with multi products under one order with different categories then the inventory costs rises for the company.

1.2.2 Demand Uncertainty

As higher demand leads to higher inventory costs, Drop Shipment allows a retailer to avoid the same as the inventory is maintained by the manufacturers. On the contrary, it becomes difficult to pool the goods in multi categorical customer orders.

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1.2.3 E-Tailers Mean Revenue

A large e-tailer can leverage its economies of scale in order to reduce the inventory costs right from order processing to packaging resulting in adopting the traditional approach. Moreover, as Amazon.com reports that historically, inventory and warehousing costs accounted for approximately 10-15% of the final goods sold. Thus, it is well documented that the fixed costs are significantly higher if the e-tailers own the inventory and warehouses. Thus, companies with high net revenue would support in investing in huge warehouses but the smaller firms, may choose to adopt the drop shipment approach in order to use the funds in operational activities.

1.2.4 Product Size/Weight, Product Obsolescence, and Cost of Capital

  1. Product Size/Weight – Few products define themselves to be drop shipped. For example, any heavy and large products intend to be more costly if they are stocked internally and moreover it leads to capture a huge warehouse space. Thus, such type of products can better be delivered using the drop shipment approach as it also follows an economical method of delivery. Using Drop shipment for such products also tend to make a significant impact on inventory holding costs.
  2. Product Obsolescence – Highly perishable goods like grocery or flower severely involves high over-stock inventory losses as they become obsolete after a certain period of time for instance flowers durability may likely be a day or two. Thus, such products involve high holding costs with specific requirements and hence, drop shipment method is highly suitable for such type of goods.
  3. Cost of Capital

As it is well interpretated that carrying the inventory includes a loss of opportunity cost over capital as the carrying costs incurred over inventory may have been well utilized for some better purposes and henceforth, a e-tailer being able to borrow cheap capital would be interested in maintaining high inventory rather than drop shipment which helps to take the advantage of opportunity cost of capital.

1.3 Outsourcing Approach

At a matured phase of inventory control, Amazon decided to outsource its inventory management and concentrate more on its core business activities and expand profoundly which could help the company capture a huge market share. (Pillai, 2004).

1.3.1 Pros of Outsourcing:

  • Results in better and faster shipping the orders.
  • Less amount of inventory is to be maintained which leads to less number of warehouses, distribution centers and inventory costs.
  • Results in high revenue.

1.3.2 Cons of Outsourcing:

  • Highly dependent on the distributors which involves high risk of losing customer satisfaction.
  • Outsourcing activities may lead to loss of jobs in the organization (Brandenburg 2005).

Discussion and Prescription

Based on the analysis, it can be determined that Amazon.com gradually developed better strategies supporting its Inventory Management. When Jeff Bezos started Amazon.com in a small garage, he decided to stay away from managing inventory and warehouses but today Amazon holds its reputation throughout the world for its world class Inventory Management. Amazon faced many problems in respect to inventory control and managing its various warehouses suffering huge losses. Amazon has succeeded in implementing the correct strategy managing its inventory. As referred above, the warehouse approach is not much of help to Amazon.com in order to curtail its costs and earn high profits as the warehouse is mainly associated with the products that have high demand and unlike Amazon where the sales are mainly on horizontal scale of categories and thus this led Amazon to adopt the Drop Shipment Approach which did help Amazon to grow from its huge losses but it was still not the correct strategy of Inventory Management for Amazon.com as the main outback for Drop Shipment Approach in relation to Amazon.com was that about 33% of Amazon.com’s single orders are multi categorical products and thus Amazon needs to pool the specific order from different manufacturers to their own warehouse and then ship the collective goods to the customer and this held for order delays and customer being dissatisfied and moreover, it resulted into high inventory costs. In 2001, when Amazon.com outsourced its inventory management, it also saw the first ever profit of $5 Million in 7 years of business activity. Thus, it can be said that Amazon.com adopted the correct strategy over its Inventory Management at a gradual scale of development.

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Manage on its own v/s Outsource Inventory Management

Outsourcing

Outsourcing is recognized as loyal service providing system. The term ‘outsourcing’ refers to as a system wherein goods and services are procured from the external sources to the organization. It is a system which accounts for the whole system of planning, management and operation to function from a self-regulating third party.

Analysis & Diagnosis of the right strategy for Inventory Management

The below are the factors that discusses the impact of outsourcing on a company

2.1 Rate on Assets

By the adoption of outsourcing facility, a company can cut down on its investments in warehouses, costs involved from order picking to packaging, transportation vehicles and IT. Thus, adopting outsourcing facility, the companies can save on the outlay of capital leading them to make a useful investment in the core competencies beneficial for the development of the business.

2.2 Flexibility

There is a near impossibility in predicting the future logistics requirements as the markets are outperformed and replaced by the new products. Thus, just as the products develop and change, so does the logistics require changes and henceforth outsourcing has proved to be a life saver for many organizations.

2.3 Management, Labor and Political Considerations

Managing the internal functions with due management pressure is very difficult and thus outsourcing the inventory activities to a third party helps to concentrate on basic business functions and solves the distribution problems. Moreover, outsourcing helps to eradicate the corporate political differences. But laborers are well acquainted with the outsourcing activity which may lead to some job losses.

2.4 Customer Oriented and Expertise Services

Outsourcing the logistics activity to an expertise third party leads to better determined services with better efficiency and customer focused. Thus, Outsourcing improves company’s overall creditability.

2.5 Global Competence

Outsourcing activity can help in increasing the global prospective, development of foreign distribution centers and equip in making quick international shipments. Thus, in order to step on global footprints, outsourcing may prove to be very fruitful.

Discussion and Prescription

Outsourcing Strategy has wisely proven quite beneficial for Amazon.com as the company first time saw the profit of $5 million in the Q4 of 2001 after Outsourcing its Inventory Management. Prior to achieving the profit, Amazon.com suffered from losses all over its 7 years since its commencement. Moreover, the company suffered a loss of $545 million in the Q4 of 2000 and henceforth the company benefitted with a great boom after Outsourcing its Inventory Management. Implementing the Outsourcing Strategy, Amazon.com discontinued its two distribution centers and cut down approximately 4000 jobs throughout its centers. Moreover, Amazon.com also reduced its customer contacts per order by one third after improving on its self service tools and thus company decreased its customer queries on whereabouts of their orders by one half. Amazon.com not only gained a huge success on its services and financial position but its main outcome i.e. Inventory which the company reduced about 38% quarter on quarter outsourcing the Inventory Management. Thus, outsourcing the company’s Inventory Management was a wise decision made by Amazon.com. (Brandenburg 2005)

Amazon: Promoting oneself v/s Selling competitors products

It is quite controversial when we say that any e-retailer is going to allow its competitors to sell their products on e-retailer’s website. It is quite hard to chew that instead of promoting a brand of its own, Amazon.com decided in 2001 to give the consumers a wide range of choice comparing to its competitors and launched a new face of its online shopping triumph where Amazon sold many of its competitor’s products.

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Analysis & Diagnosis

Factors that contribute towards Amazon.com’s decision are as below:

3.1 Multi-Dimensional Approach

Entering into collaborations with several companies, may give Amazon a high level of advantage in entering into multi-dimensional product categories which may increase the customer share.

3.2 Amazon as a Gatekeeper

According to “Amazon would act like a gatekeeper to the apparel chains as opposed to actually selling for them”. Thus, Amazon is intended just to fulfill the orders from the companies whose products are sold on Amazon.com and in return Amazon would receive a certain % of Sales as commission.

3.3 Brand Name to Prosper, Regional Retail Penetration and Brand Awareness

Amazon’s prospects rise higher if any Multi National Brand sells its product on its website as Amazon will get the opportunity to capture a wide market share. Thus, it also leads into greater Regional Retail Penetration and Brand Awareness.

3.4 Partnership Strength

The only thin thread of such a decision would be any partnership clashes between Amazon.com and its Partner company who sells on its website because any problems between the two companies may damage their service and reputation.

Discussion and Prescription

According to the Analysis and Diagnosis above, we can predict that Amazon’s decision in selling its competitor’s merchandise in line with its own could be a fruitful move as it may prove its worth in capturing a wider market and customer share along with higher customer satisfaction as it can provide the customer’s choice of brand and compare the same with the others and make a wise purchase decision. Apart from consumer’s point of view, Amazon do not have much work under its belt maintaining such type of agreement as it merely acts as a gatekeeper as the shipment lies in the hands of the company selling its product and Amazon gets a hefty commission on the sales and thus Amazon do not need to maintain Inventory. One of the major benefactors of such collaboration would be that Amazon would create a platform for entering into all types of retail segments with a brand name already well established and capture a market share with it. Entering into multi segment products, Amazon then can sell many other products by promoting it. Thus, it can be determined that Amazon’s decision to sell its competitor’s products along with its own at the same platform of comparison will help benefit the company in tremendous ways instead of harming its sales.

Bibliography

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