To Share or Not? - Choosing the Right Store Distribution Model Boosts Profitability

As businesses contend with challenges facing their supply chains and high inflation, considering different approaches to store distribution can have significant rewards and deliver competitive advantage in cost and speed. Recent examples we have seen include a retailer reconfiguring their approach to distribution and moving from Direct Store Delivery from each brand to running a central DC. This reduced inventory days by c.20-30% and delivered an improvement to the bottom line of c.0.5% of sales due to the reduction of in-store staff required to receive deliveries. 

There are two primary models of distribution to retail stores, i) Direct Store Delivery and ii) delivery through a centralised Distribution Centre.  

 “Direct Store Delivery” (DSD) 

The DSD model sees suppliers delivering their products directly to retail stores (see Figure 1). This model can offer greater speed, and places complexity of managing distribution with the supplier. The DSD model is popular with suppliers of perishable products (e.g., milk and bread) that need to be delivered frequently and quickly, and fragile products (e.g., bread and crisps) that are easily damaged during the distribution process. Small retail groups may also be too small to have their own DC and thus require DSD from their suppliers. For these smaller retailers, recognising the tipping point when cost savings can be realised from using a DC is key.

“Distribution Centre” (DC) 

Under the DC model, suppliers make deliveries to a central warehouse and the retailer then takes responsibility for distribution to their stores (see Figure 2). This model is most cost effective with large, infrequent deliveries from suppliers with goods that can subsequently be distributed to stores alongside other goods, thus benefiting from economies of scale. It enables stores to receive a consolidated delivery which can significantly reduce the in-store labour requirement to process deliveries. 

However, there is typically more handling of the products and slower time to market, which means it may not be suitable for easily damaged or time-sensitive goods.  

L.E.K. recently worked with a national UK specialist retailer which had transformed its distribution model, switching from a DSD model from multiple suppliers to a central DC. This improved efficiency, reduced costs through fewer deliveries, decreased stock levels in individual retail stores, and released cash for reinvestment in the business by delivering a 20-30% reduction in days inventory. The client was also able to secure a discount from suppliers in return for streamlining their distribution process (as they could now deliver to one DC rather than many stores).

Differing perspectives of Retailer and Supplier and appropriately pricing distribution 

The use of DSD or a retailer’s DC shifts the responsibility and costs between the supplier and retailer, and naturally is a part of calibrating the price paid by the retailer to the supplier (i.e. the retailer should pay more to the supplier for DSD rather than just one delivery to a DC). 

For a retailer considering setting up a DC, understanding if the new costs will be offset elsewhere is essential. When a retailer has a DC, correctly understanding the true cost of using their DC is key to knowing what discount is required from a supplier vs. one offering DSD. 

For a supplier offering DSD, understanding at what price the retailer can utilise its DC is key to negotiating a fair price for distributing direct to store. 

There is usually plenty of data to help a retailer or supplier understand these costs if it is collected, however retail buyers and suppliers typically have insufficient information at hand to correctly value the different distribution models, for example the benefit of alleviating pressure on a DC, or of reducing in-store labour requirements, would require careful analysis. 

Future direction 

While some high-profile suppliers in the US such as Kellogg’s and Nestlé have moved from DSD to the DC model in recent years, and Discount retailers in the UK, famous for their low-cost efficiency, continue to insist on the DC model, emerging trends and technological advances point to a bright future for the DSD model too, in specific circumstances. 

Kellogg’s found that with significant advancements in warehousing technologies over the last decade, DC’s can deliver cost efficiencies for the supplier, its retail partners, and the customer, allowing for value creation across the supply chain. Similarly, Nestlé were able to reduce their headcount by 4,000 by switching to a DC model. 

Sector by sector it is important to consider how market developments may impact which model is best. For example, in print newspapers, a DC model is used which pools distribution with other publications for daily delivery (given the time sensitive nature of the product), but separate from other products (e.g. F&B etc). However, the long-term decline in volumes, combined with increasingly efficient DC systems, may mean sharing distribution with other products could soon become a better option. 

Understanding the true cost position and the emerging trends will enable suppliers and retailers to stay ahead of developments and maintain robust, low-cost supply chains. L.E.K. closely monitors emerging challenges, including fuel and labour costs, congestion and traffic, as well as warehouse costs, and will continue to work with suppliers and retailers to choose and optimise the best distribution model to suit their changing needs.