Fluent Essays

Read the passage and answer the questions Harvard Business School 9-195-124 October 14, 1994 Research Associate Theodore H. Clark prepared this case under the supervision of Professor James L. McKenney as the basis for class discussion rather than to illustrate either effective or ineffective handling of an administrative situation. Copyright © 1994 by the President and Fellows of Harvard College. To order copies or request permission to reproduce materials, call 1-800-545-7685, write Harvard Business School Publishing, Boston, MA 02163, or go to http://www.hbsp.harvard.edu. No part of this publication may be reproduced, stored in a retrieval system, used in a spreadsheet, or transmitted in any form or by any means—electronic, mechanical, photocopying, recording, or otherwise—without the permission of Harvard Business School. 1 Campbell Soup Company: A Leader in Continuous Replenishment Innovations Campbell Soup Company, one of the largest branded product manufacturers in the United States, was a leader in efforts to improve the efficiency of the U.S. grocery distribution channels, the process through which products and information flow. During its more than 100- year history, the company maintained excellent relationships with its retailer and wholesaler customers and was committed to improving channel efficiency and effectiveness in ways that would prove mutually beneficial for itself and its customers. Improvement required an innovative approach to channel restructuring, one that would allow customers a choice of how quickly to change and yet provide sufficient incentives for assisting Campbell in eliminating unnecessary costs. Continuous product replenishment (CPR)1 was an important means of improving channel efficiency. This new channel design required fundamental changes in processes and policies, but offered significant savings for retailers and wholesalers adopting it. Campbell was one of the early innovators in continuous replenishment, introducing this new ordering process in 1991. CPR offered the potential to significantly reduce production costs as well as inventory levels and logistics costs, but production cost benefits would become significant only if 30% to 50% of Campbell's volume were provided through the new process. By August 1994, 16% of Campbell's volume was ordered by customers using CPR. Management wanted to accelerate CPR adoption to realize its full potential. Harry Tetlow, VP of logistics was certain that Campbell could provide incentives sufficient to increase the percentage of CPR customers to 50% over the next few years, but the financial implications of rapid expansion needed to be carefully considered. Because CPR eliminated excess inventory in the channel, a rapid increase in its adoption would reduce sales. Any price reductions to encourage CPR adoption would also reduce margins. Although increasing CPR adoption could provide the company with important long-term benefits, the immediate costs were more obvious than the eventual benefits. Company and Industry Background With fiscal year 1994 sales of $6.7 billion and net profits of $630 million, Campbell was one of the largest closely held companies in America. The founder's family still controlled approximately 1. Most of the industry referred to continuous replenishment as CRP, but Campbell preferred CPR. Both terms referred to identical processes for replenishment. 11 195-124 Campbell Soup Company: A Leader in Continuous Replenishment Innovations 2 60% of the stock. Maintaining a stable dividend payout policy was very important to the family, as was consistent growth in sales and earnings. Acquisitions of other branded-product companies provided an important source of growth, although most of the profits and a third of total sales still came from the condensed-soup products, first developed in 1899. Acquired product lines included Franco-American Food Company (1921), Swanson Foods (1955), Pepperidge Farm (1961), and Vlasic Foods (1978). The company's flagship product line, the Campbell's red-and-white cans of condensed soups, provided its central focus, and much of its expansion over time involved integrating backwards (buying the supplier) packaging and raw materials necessary for production. Backwards integration was important to standardize and control raw materials quality and to control costs. The ability to control costs and supply provided Campbell with important production advantages that assisted it in gaining the leadership position in the condensed-soup market. Campbell effective marketing combined with low-cost production had forced other national-branded-product producers to abandon the condensed-soup market, leaving private-label and noncondensed soups the only remaining competition. Campbell's "red-and-white" soups were produced in four plants, each capable of producing almost any of the company's canned or bottled food products, including the entire soup line. Plants were located in geographically separate regions, enabling Campbell to reduce logistics costs of receiving raw materials and transporting finished products to customers. Each of the plants produced most of the product line, but some products with limited sales or special production requirements were produced only in a single plant. For these limited-production products, Campbell shipped inventory between plants to enable each plant to serve the needs of channel customers within that geographic territory on a completely independent basis. Campbell had backwards integrated into raw materials supply and production for many ingredients, but also purchased some of these same ingredients outside the company during peak production periods. Demand fluctuations in the sales cycle resulted in major production inefficiencies, with as much as 40% of annual sales volume for some products ordered during a single six-week promotion (see Exhibit 1). From raw materials production to plant operations, artificial peaks in demand caused by forward buying during product promotions created significant production inefficiencies. Forward buying involved purchasing at the end of a manufacturer promotional period products sufficient to meet the retail consumer demands for many months following the promotion. It reduced average purchase price for products, with some retailers and wholesalers able to purchase almost an entire year's sales volume of some products at promotional prices. Forward buying created significant purchase price savings for Campbell's customers, but increased their storage and handling costs and increased Campbell's production, storage, and logistics costs. Product Pricing and Promotions Pricing for Campbell's products had been essentially constant during the 1940s and through the 1960s, and promotions were virtually nonexistent. Growth during this period came from providing good food at a good price, without the need for channel promotions. Increased inflation in the late 1960s and 1970s forced the company to abandon this constant- pricing strategy. Increased competition from private-label products also encouraged use of promotional incentives to increase channel commitment to the company's product line. Price increases were accompanied by promotional rebates, allowances, and other marketing incentives, encouraging channel customers to increase purchases of Campbell's products. Pricing allowances expanded over time, with discounts offered for special displays, advertisements, promotional sales, product backhauling,1 and consumer 2.Backhauling referred to retailer pick up of products at the manufacturer and providing transport to their warehouse. An allowance was paid by the manufacturer to reflect the avoided shipping costs. 22 Campbell Soup Company: A Leader in Continuous Replenishment Innovations 195-124 3 Figure A Effect of Promotions on Demand coupon redemption. Regional promotions and variable customer allowances further increased pricing complexity. Product promotions had existed in the industry to a limited extent for decades, but they expanded dramatically during the 1970s, partially because of the imposition of price controls by President Nixon in 1971 as part of an attempt to reduce inflation. The combination of high inflation, relatively low interest costs, and large promotional discounts made the economics of forward buying very attractive for chains, with many retailers discovering that smart buying was more important for increasing profits than smart selling. Retailer enthusiasm for trade promotions stimulated many merchandising program variations, including increased coupon offers, new SKUs at special prices, weekend specials, holiday specials, and combination packages. Product procurement cost depended upon the different prices, allowances, and incentives offered by manufacturers, making it almost impossible to determine actual cost at any time for a single product on the shelf. An inability to understand costs and the discounts available from aggressive purchasing resulted in increased focus on "buying for profit," rather than "selling for profit." Reliance on promotional programs coupled with forward buying increased retailer inventories and required manufacturers to maintain large inventories in order to meet the high demand artificially created by forward buying during promotional periods. Variation in consumer demand was increased by store promotion activities, and variation in manufacturer demand was further increased by retailer forward-buying activities, making changes in demand difficult for manufacturers to forecast accurately. Uncertainty about total demand and large fluctuations in periodic demand not only increased manufacturer inventory requirements but also resulted in higher manufacturing costs than would have been possible in a "direct pull" through demand environment. The combination of promotional pricing and forward buying effectively decoupled actual consumer demand with manufacturer sales to retailer and wholesaler customers. Decoupling increased channel lead times and exaggerated demand variations, as illustrated in Figure A, creating dramatic inefficiencies in the channel. However, even though the use of promotions and forward buying was inefficient for both manufacturers and retailers, their elimination was difficult, because manufacturers had learned to manage quarterly and annual earnings by adjusting promotional levels, and retailers and wholesales had become dependent on forward buying as an important source of profits. Retail Grocery Channel The retail grocery channel, the most important one for sale of Campbell's products, consisted of manufacturers, distributors,3 and retail stores (see Exhibit 2). Campbell generally did not distribute products directly to individual retail stores, except for bakery products which it delivered through a separate subsidiary (Pepperidge Farm). It sold all canned and frozen products to wholesalers or retail chains that provided their own warehousing and distribution. Approximately 45% of Campbell's retail grocery sales volume went through self-distributing retail chains, and 47% went through wholesalers that served primarily small chains and independent retail stores. Some wholesalers also supplied large chains, but most served smaller chains and independent retail stores. Other retail formats, such as mass merchandiser and club stores, provided only 8% of Campbell's sales volume. 3. Distribution and warehousing of products could be provided by wholesalers to retail stores or by large chains to their own retail stores. Most retail grocery chains provided their own distribution function. 33 195-124 Campbell Soup Company: A Leader in Continuous Replenishment Innovations 4 Although concentration nationally for retail grocery chains was low, most local markets were highly concentrated, with two or three chains representing 70% or more of retail sales in a single market. The level of concentration varied by market, but one regional chain often controlled 50% or more of total grocery sales within a single area. There were no truly national grocery chains, although several large chains had stores in multiple regions. In general, each region operated independently, with little centralized control of decision making for these multiregional chains. Grocery retailers offered a broad range of products, with a typical supermarket stocking approximately 6,000 SKUs (stock-keeping units) in 1960 and 18,000 in 1993. Some grocery product SKUs had store turnover exceeding 100 times per year, meaning that an average of less than three days of sales was stocked on the shelves. However, most of the SKUs in an average retail store were slow-moving general merchandise and low-volume grocery products, with turnovers averaging 12 times per year or less. Products were normally shipped to retailer or wholesaler warehouses in large quantities, with 5-15 SKUs shipped in single-product pallets on a fully loaded truck. Retail stores generally received from the warehouse truckload deliveries daily of a wide variety of products, which they then stocked on the shelf in case quantities to minimize product handling at the warehouse and the store. Some very slow-moving items (e.g., frying pans) were distributed as individual units. Almost all grocery items were sold by the retailer in unit quantities, with the channel providing an efficient logistics process for getting truckloads of a single manufacturer's products to consumers who purchase a variety of products in unit quantities. Profit margins for grocery retailers were low, typically ranging from 1% to 3% of gross sales before tax. Average sales volume was $8 million to $12 million per year, and an average customer purchase was approximately $16.00 per transaction. With low unit prices and high product and transaction volumes, store operating profits were highly dependent on efficient operations. More than 80% of all supermarkets had installed check-out scanning systems by 1993 to handle the large volume of retail transactions. Total sales volume per store and per square foot of retail space was a critical factor influencing retailer profitability. Because newspaper advertising was a significant cost for retailers, regional market share was a critical factor affecting profitability in that it leveraged the fixed costs of regional advertising. Warehouse-to-store-distribution economies of scale in a geographic area also encouraged regional concentration. Even though a single chain might control a large share of a regional market and enjoy a cost advantage over other chains in the region, it also faced competitive pressure from alternative-format retailers, which used very efficient distribution systems and policies across the channel, thereby limiting pricing flexibility for grocery retailers. In addition, entry barriers were moderately low in grocery retailing, enabling new competitors to enter if retailer gross margins were too high. Regional scale advantages were significant, forcing a new competitor to make a large investment on entering a new territory. However, even large, established chains could be attacked by new entrants if profit margins were high or if chain operations became inefficient (e.g., because of high labor costs). Store format innovations had enabled new entrants to overcome established chain advantages, leading to dramatic share losses for some chains that did not adopt new innovations, such as larger store formats and extended range of service offerings. Increased competition from aggressive, low-cost grocery chains (e.g., Food Lion) and alternative format retailers, including mass merchandisers (e.g., Wal-Mart) and club stores (e.g., Sam's Club), forced traditional retailers and wholesalers to find ways to reduce costs and improve operations in order to remain competitive. Mass merchandisers, club stores, and some low-cost grocery chains offered a limited assortment of grocery products at very low margins, resulting in attractive retail pricing for consumers. Alternative retail formats for grocery products (primarily mass merchandise and club stores) grew rapidly during the 1980s, creating a serious threat for traditional grocery product retailers. A McKinsey study of alternative distribution channels for traditional grocery products, published by the Food Marketing Institute in 1992, demonstrated that more efficient distribution and merchandising practices enabled them to offer lower prices to consumers than did traditional grocery retailers. Mass merchandisers and club stores channels were less important for Campbell than for many other manufacturers, but the efficiency improvements 44 Campbell Soup Company: A Leader in Continuous Replenishment Innovations 195-124 5 enabled by new distribution processes in these alternative-format channels attracted management's attention. Working with supermarket chains, wholesalers, other manufacturers, consulting firms, and several industry trade associations, Campbell participated in developing a model for improving the efficiency and effectiveness of the total grocery supply channel. Known as the Efficient Consumer Response (ECR) model or vision (see Exhibit 3), it was first described in early 1993 in a report presented to the industry by Kurt Salmon Associates. Following this presentation, a number of project committees were established with manufacturers and distributors4 to assist in developing the components of ECR to enable them to adapt to it. Manufacturers, wholesalers, and retailers all had incentives to improve the efficiency of the existing channel in an effort to slow the growth of alternative-format chains competing with traditional grocery channels. For manufacturers, growth of alternative-format chains increased the risk of substitution from private-label products, because most of the retailers were national in scope and had introduced nationally advertised private-label products for their stores. National store brands weakened the power of manufacturers' branded products. Because most of a manufacturer's equity value was based on the strength of its brands with consumers rather than on production assets or capabilities, the growth of powerful national retail chains inclined to use private-label products to weaken national-brand franchises was clearly a threat to existing branded-product suppliers. One part of the ECR vision was improving the product replenishment5 process by implementing continuous replenishment. Continuous replenishment coupled actual consumer demand and manufacturers' sales with distributors, eliminating artificial fluctuations in demand created by forward buying during promotions. Campbell was working with channel partners to implement all aspects of the ECR vision, but because CPR represented the most significant opportunity to improve channel performance in 1994, it thus received more attention than other ECR initiatives. Although generally implemented in combination with levelized pricing (often called "everyday low pricing," or EDLP), continuous replenishment did not require it from retailer to consumer. Promotions were still possible using continuous replenishment, but required careful management to eliminate inefficiencies or problems in the process. Using CPR in combination with retailer and manufacturer promotions required sophisticated planning and control systems to avert stockouts or excess inventories in the channel. Relationships between Campbell and its retailer and wholesaler customers were generally quite good, and senior management was reluctant to introduce any new policies that would strain them. Elimination of trade promotions through introduction of an EDLP policy for all customers, a strategy pursued by some manufacturers, could eliminate forward buying and improve the linkage between retail demand and manufacturer sales. However, it was not considered a viable option for improving channel efficiency at Campbell, as it would weaken important channel relationships. An alternative approach was needed to provide positive incentives to adopt CPR and other innovations to improve channel efficiency, without forcing EDLP or other changes on the channel. Campbell's Production Process The demand fluctuations created by forward buying during promotions (see Exhibit 1) resulted in large inefficiencies in Campbell's production process. To meet the peak demand for 4.In the context of the ECR committees, the term distributor was used to describe either wholesalers or self- distributing retail chains. In this sense, distributor described a function performed in the channel rather than a single type of firm providing that function. 5.Replenishment ordering included all orders for replacement of product already stocked on the retail shelf. Adding or changing products was not considered replenishment ordering. 55 195-124 Campbell Soup Company: A Leader in Continuous Replenishment Innovations 6 Chicken Noodle Soup during the January promotion, raw materials production began increasing the prior spring. Multiple periods of peak processing and extensive storage capacities were required to meet these promotional peaks; consequently, production costs increased, as did customers' storage and handling costs for product purchased during promotions but not sold until many months later. Although Campbell believed that promotions were effective in increasing retail consumer demand, it made little sense from a channel perspective to produce products during peak periods at high production cost so the retailer could store the product for months and then sell it during slow production periods when the cost of packaging and distribution would have been much less for Campbell and the retailer. To meet the peak demand for Chicken Noodle Soup during the January promotion, chickens were processed in large quantities beginning in the prior May and stored in huge freezer storage facilities. Storing frozen chicken was expensive, but was necessary to meet the fall season's production requirements. Many additional chicken boners and processors were hired as seasonal workers to supplement the permanent work force and then laid off once the promotional production was completed. Chicken processing expanded dramatically, with two 10-hour shifts working 6 or 7 days per week instead of the single 40-hour per week shift that was typical during nonpeak periods. Processed chicken and other materials used in soup production were produced ahead of time and stored until needed. Some preprocessing of soup and other food items was normal, but the large inventory capacity required to handle the January promotion of Chicken Noodle Soup was unique to this single product. Thus, reducing the spikes (dramatic increases) in demand would reduce freezer storage needs both in outside facilities and within the company, as well as reduce reliance on higher- cost outside suppliers for raw materials. Because raw materials (e.g., potatoes, meat, steel) represented 75% of Campbell's total products cost, managing their cost was very important. Actual production for the Chicken Noodle Soup promotion began in September and continued through January. Because it required special equipment, only 10%-20% of the production lines in a plant could be used for Chicken Noodle Soup. All other products requiring this type of equipment had to be produced in advance of demand and stored in inventory to free the lines for the dedicated production of only this one product to meet the promotional demand peak. Two 10-hour shifts operated the production lines 6-7 days per week during the peak production period, and finished products were stored until the promotion, requiring extensive storage facilities inside and outside the company. The additional production workers, as well as the substantial overtime pay for the permanent workers, increased labor costs. The promotional spike also increased storage costs at the processing plants for both Chicken Noodle Soup and other products that used the same production lines. The extent of production-cost savings that could be realized through reducing the peak demand during promotions was not known, but Tetlow and Meillier, VP of finance for Campbell North and South America (CNASA), believed that the savings from increased CPR use to reduce production spikes could easily be several million dollars per year. Efforts to reduce production costs by elimination of promotions were not viable, however, if they resulted in loss of channel sales. CPR both increased sales through the channel and reduced promotional spikes, creating strong financial incentives to expand it. Realizing significant savings would require restructuring the process used for raw material production and processing, and Tetlow and Meillier both believed that it would require at least 30% of total volume through the CPR process. Developing the CPR Program By late 1990, Campbell management had become aware of logistics and channel replenishment innovations P&G was pioneering with Wal-Mart and other customers. In September 1990, several Campbell executives met with the P&G executives involved and became convinced that continuous replenishment would provide Campbell and its customers with significant logistics cost 66 Campbell Soup Company: A Leader in Continuous Replenishment Innovations 195-124 7 savings and improved customer service levels (e.g., reduced stockouts). In October 1990, Tetlow, then director of logistics, presented a proposal for developing a new CPR logistics program to Herb Baum, president of Campbell North America, and received funding of $750 thousand to develop the concept and demonstrate its benefits. Within several weeks of the initial discussions with P&G, senior managers at the H. E. Butt (HEB) grocery chain approached Campbell's management regarding the possibility of adopting the continuous replenishment program with HEB as an early site to test and develop it. Campbell accepted the invitation and, by early 1991, became one of the first manufacturers to adopt this new product replenishment approach. The CPR Pilot Program with HEB Using a PC-based process (for both companies) that was manually intensive, the initial CPR pilot program with HEB demonstrated the process's potential to improve channel performance dramatically, even with an inefficient system (e.g., a PC with manually processed inputs and data). A mainframe program, whose development started shortly after the initial CPR linkage with HEB, replaced the PC system about six months after the introduction of CPR. The PC system used in the initial pilot with HEB was based on an internal Lotus spreadsheet application developed by Ed James, then senior manager of logistics. James began working for Tetlow in 1987 to manage plant scheduling, planning, and interplant logistics. In 1994, he was promoted to director of Logistics, reflecting the increasing importance of the CPR group he managed. The spreadsheet application was developed initially to improve the efficiency of interplant transfers, used to meet unusual demand peaks and for products that were not produced at all plants. James modified the simple PC system to support CPR for the early implementation with HEB, but the simple PC system required extensive manual data entry and processing to function. Even so, the use of this prototype system with HEB enabled Campbell to learn a lot about implementing CPR and assisted in the specification and development of the mainframe system. Use of the PC system was not intended to test or experiment with CPR, but was a means of quickly implementing it with HEB. James explained: We knew that CPR was going to work, so the pilot was not a test. The pilot using the PC allowed us to learn quickly how to change the process. Working with HEB in this pilot stage helped us a lot in developing our CPR systems and processes. With the CPR process, the retailer transmitted data on product shipments from its warehouse to its stores, and the manufacturer determined order quantities required to maintain adequate warehouse inventory levels. Vendor-managed inventories, another term used by some grocery executives to describe continuous replenishment, was a dramatic shift in attitudes for both retailers and manufacturers. Traditionally, manufacturers tried to get retailers to buy as much product as possible, with the view that "a loaded customer was a loyal customer." Promotions were used to encourage customer "loading." Retailers used sophisticated buying systems to determine the optimal level of product purchases, given a specific promotional deal, using assumptions of expected future product pricing and deals and expected sales over time. With CPR, retailers trusted the manufacturer to provide only the products actually needed to adequately serve expected consumer demands. CPR Mainframe Systems Development The initial mainframe CPR system development required about six … 1. Trade promotions are one cause of bullwhip effect in Campbell's supply chain. What are reasons for trade promotions? Who were most concerned about the negative impact of "bullwhip" effect? Are there a consensus in Campbell's channel to eliminate the causes of bullwhip effect? 2. What are the payoffs for sharing information across the supply chain for condensed soup? What are complementing organizational changes needed to achieve these benefits? 3. Why does Campbell’s CPR implementation require changing the decision-making process for inventory management for condensed soup? Couldn't order decision be left in the hands of grocery chain buyers? 4. What is the relationship between CPR, product pricing, Every-Day-Low-Price (EDLP), and product promotion? Why do all of these have to be synchronized to achieve the benefits of CPR? 5. How easily could these ideas and systems be implemented for a different product, in a similar industry (consumer packaged goods)? What would you worry about if you ported the idea of CPR to a different product? 6. How did the bullwhip effect hurt Campbell and its retailers? 7. What caused the bullwhip effect in Campbell's supply chain? 8. What was Campbell trying to achieve through CPR? 9. What were the obstacles Campbell must overcome in CPR implementation?