Virtual inventories get real

About 10 years ago, when the Internet frenzy was taking off, many in the industry predicted the rise of virtual fulfillment and, possibly the end of inhouse fulfillment.

“At the beginning of the Internet, people claimed that everything would be virtual and that they didn’t need to worry about fulfillment,” says Serguei Netessine, assistant professor of operations and information management at the University of Pennsylvania’s Wharton School of Business.

But just as most of the dot-com stocks didn’t pan out, the notion of virtual inventory did not immediately become a widespread practice.

In the virtual-supply-chain model, a merchant sells the products but never actually takes possession of them; rather, the supplier drop-ships merchandise directly to customers as orders are received. Many merchants’ early attempts at virtual-inventory models came up short. The wholesalers and distributors that took on the task of fulfilling orders to consumers often were unprepared. “They were equipped to ship pallets to retailers,” Netessine says, not to send single orders to individual customers. Getting products to consumers required a different set of business processes and equipment than the wholesalers had in place at the time. As a result, orders often weren’t filled in a timely manner. And few merchants had the technology needed to track order fulfillment.

During the past few years, however, a growing number of retailers and suppliers have become more adept at working within a virtual-inventory model. For starters, more wholesalers have put into place the picking, packing, and other equipment they need. In addition, many merchants have developed their own or found third-party applications that allow them to reliably connect, in real-time, with suppliers.

For The Guild, a Madison, WI-based merchant of original art and gift items, the ability to say that the products are shipped straight from the artist offers a key marketing advantage. The craftspeople who supply The Guild with merchandise create the products right in their studios and ship them directly to customers. “This is art, not items that are designed and then mass-produced overseas,” says president Michael Baum.

A virtual-inventory, or what Baum refers to as a zero-inventory, model is intrinsic to The Guild’s business. “We couldn’t run a business like ours any other way,” Baum notes. The Guild’s Website offers the work of some 700 artists, many of whom produce limited-edition or one-of-a-kind pieces. Bringing all those items into a single warehouse to fill orders would require a risky investment in inventory.

Many of the merchants deploying virtual inventory models sell via primarily the Internet. While a virtual-inventory approach isn’t exclusive to the Web, that channel can best leverage its benefits, says Frank Poore, CEO of Albany, NY-based CommerceHub, a provider of supply chain solutions. Internet merchants can add items to their online product databases at little cost, taking advantage of the breadth of inventory a virtual-inventory model makes possible.

A case in point is Shop.com, a Web merchant based in Monterey, CA, that sells products from about 1,300 suppliers. The suppliers hold the inventory and provide electronic data feeds into Shop.com’s Website. Other companies that also offer a wide range of products, such as Wal-Mart and QVC, have significant inventory costs, notes Shop.com president Bruce Sellers. “So it’s hard [for other merchants] to offer the variety of products we do,” he says. “It’s all a matter of economics.”

In stores, the physical space limits the amount of inventory that can be added. Some brick-and-mortar retailers may expand their inventories beyond what the physical store can hold by placing Internet kiosks in their stores. Customers place orders from these just as they would from the Web, and the retailer may use a virtual-inventory system to fill the order. The kiosks often are used for products that are hard to stock, such as household appliances.

THE NUTS AND BOLTS

For a virtual-inventory system to work, you need a way to electronically transmit orders from your system to your suppliers’ systems. Then the supplier needs to let you — and your customers — know that the goods have shipped.

The Guild, for instance, is connected to its 700 artist members via an extranet and proprietary software. When a customer places an order on The Guild’s Website, the software verifies the credit-card number and sends an acknowledgment of the order to the customer. The order information is electronically transmitted to the appropriate artist, who receives an e-mail with instructions to log onto the extranet. The artist does that and enters a ship date for the piece; because some items are custom-made, not all orders ship immediately. This information is then transmitted to the customer.

Once the item is ready to ship, the artist opens the order record on the extranet and enters its size and weight. He links to United Parcel Service through the extranet to obtain the shipping fee and the tracking number and to print a shipping label. The artist e-mails the customers with the package tracking information; The Guild debits the customer’s credit card once the item has shipped; the merchant then pays the artist.

The management at The Guild developed its own software application because when it began its e-commerce venture in 1999, the company couldn’t find a system that would handle all the tasks its system does, such as notifying the artists of orders to be filled.

MORE SUPPLIERS, MORE COMPLEXITY

As merchants begin to work with more and larger suppliers, the communication links become more varied, making for a more complicated model. At Boston-based Shoebuy.com, for instance, some 300 vendors provide virtual-inventory services. The footwear merchant’s vendors use a variety of systems to communicate with it, including electronic data interchange (EDI) and file transfer protocol (FTP), says chief operating officer Bill Pryor.

As a result, Shoebuy.com’s IT department developed proprietary hardware and software to electronically transmit inventory management, ordering, pricing, and other information to and from its vendors, Pryor says. The system required a multimillion-dollar investment.

It’s not only merchants working in a virtual-inventory model that have to modify their systems. Aerosoles, the Edison, NJ-based manufacturer/marketer of women’s shoes, manages a variety of communication and data links to gets information on its wares to the merchants with whom it works on a virtual basis.

When a merchant has to communicate order information, and when Aerosoles ships products to the merchants, the two parties transmit transaction data, such as the purchase order and invoice, via EDI. Aerosoles also uses EDI to provide the merchants with basic information on the shoes themselves, such as the description, the size, and the Universal Product Code (UPC), says Susan Johnson, wholesale manager of operations.

In addition, Aerosoles provides the merchants with more comprehensive product information, such as the materials used in the shoes and their dimensions, so that the merchants can include this in their own product databases. “They need to know enough information about the product to sell it,” says Johnson.

Retailers request this information in a variety of formats, and providing the data for each merchant can consume several hours for each shoe style. “We’re dealing with a lot of customization across our partners,” says Carol Goodhue, Aerosoles’ senior vice president of wholesale. “They’re not all on the same platform, and not everyone requires the same information.” For instance, some merchants take their own photos of the shoes, while others use pictures supplied by Aerosoles.

The company also provides inventory updates to its merchant partners once a day via EDI. To date, Aerosoles hasn’t found it necessary to provide more frequent updates, although that could change.

While the hardware required to support a virtual-inventory model typically consists of standard servers and networking equipment, the software can require a sizable investment. Merchants who’ve developed their own applications talk of investments in the seven- to eight-figure range.

Third-party applications are available. Albany, NY-based CommerceHub, for one, offers several virtual-inventory applications geared to larger retailers; the company counts Sears and QVC among its clients. Its Universal Connection Hub allows merchants to connect with just about any supplier’s technology platform, says president/CEO Frank Poore. The company’s Drop Ship Master product provides real-time order status and delivery information. Merchants pay for the system via a licensing fee and per-order charge, although Poore would not provide specific prices.


Karen M. Kroll, a freelance writer based in Minnetonka, MN, writes for American Way and Business Finance magazines, among other publications.

Is going virtual right for you?

In a study published in April 2006 in Management Science, Serguei Netessine, assistant professor of operations and information management at the Wharton School of Business at the University of Pennsylvania, along with Taylor Randall of the University of Utah and Nils Rudi of graduate business school INSEAD, examined the supply chain used by more than 50 Internet merchants. The study revealed some details about the virtual-inventory model.

For instance, a virtual-inventory system is a good idea for merchants that offer a large assortment of products. That’s the case with Boston-based Shoebuy.com, which uses virtual inventory to offer a selection of some 400,000 shoes and accessories, says chief operating officer Bill Pryor.

Because the virtual-inventory model can cut transit time, it also works well for merchants offering perishable items or products that quickly become obsolete, says Frank Poore, CEO of CommerceHub, an Albany, NY-based provider of supply chain solutions. And it’s a good bet for marketers of large, bulky products, such as furniture or household appliances. Because the goods don’t have to travel from a manufacturer to a distributor and then to the consumer, shipping costs are controlled.

But a virtual-inventory model doesn’t make sense for every business. Merchants selling great quantities of a single product usually are better off simply purchasing the merchandise — hopefully taking advantage of a volume discount — and stocking it themselves.

And marketers that want to switch from one supplier to another, perhaps to take advantage of price cuts, also usually are better off using a conventional inventory model.
KMK

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