HOW DO YOU DEAL WITH OUT OF STOCK PROBLEM IN AN E-COMMERCE MARKETPLACE?

The below is the analysis of the out of stock issue for one of the most significant e-commerce marketplace players (let’s call it HomeDotCom. No association with home.com in any way). The actual name of the company is not shown due to confidentiality reasons.

HomeDotCom is one of the major e-commerce players in the US. It is, by nature, a marketplace, and prefers not to buy inventory for cash. It works with the suppliers in 2 ways:

a) keeps their inventory at its own warehouses and ships it out when the order comes in, or b) drop-ships from the supplier’s warehouse.

We will only focus on Outdoor Décor category of products but the approach is applicable to almost any product category. Also, the suppliers (in most cases, these are manufacturers of products) are not very sophisticated market players, often don’t have logistical capabilities or strong IT infrastructure. 

PROBLEM DESCRIPTION

There are thousands of suppliers in the outdoor decor category at HomeDotCom. These suppliers obviously sell to multiple offline and online retailers and are heavily influenced by their relationships with Home Depot, Lowe’s and some other big box retailers. The retailers enforce their demand perception on HomeDotCom suppliers. The line in blue on the graph below indicates an approximation of the suppliers’ demand PERCEPTION over the course of a year as influenced by HomeDotCom competitors. The line in red indicates an approximation of the HomeDotCom customers’ ACTUAL demand for products in this category. Home Depot and other retailers tend to buy all of the suppliers’ stock for cash and HomeDotCom, because of that, goes quickly out of stock. Up until May, it is 8% and 15% out of stock, whereas from August to December it can go as high as 40% out of stock. HomeDotCom normally doesn’t buy inventory from the suppliers as it ties up cash and limits the selection of products offered on the website. It takes anywhere from 30 to 60 days to replenish the supplier inventory. The suppliers are, however, hesitant to replenish or keep stock for HomeDotCom because they don’t have enough trust in the red demand curve.

The goal is to make sure HomeDotCom is being perceived as the number 1 destination for supplier sales growth, that the company doesn’t run out of stock and improves its relationships with suppliers.

SUPPLIER INTERESTS

To establish better and stronger relationships with the suppliers, we need to understand what drives them. Suppliers are naturally interested in the following:

1. Increased sales.
2. Decreased costs.
3. Better understanding of target audience and sales data, inventory level transparency.
4. Automated business processes (reporting, invoicing, replenishment, etc.)
5. Operational efficiency. This may include optimizing warehouse costs, increasing inventory turns, reducing the risk of excess inventory.
6. Lack of returns and/or no return handling and processing.
7. Logistics outsourcing.

The solutions to the problem at hand should focus on satisfaction of supplier interests and on providing value to their business. Let’s now look at some of the challenges.

MAJOR CHALLENGES

1. Trust issue: suppliers don’t trust HomeDotCom demand curve.
2. Financial considerations: cash now (from Home Depot and the likes) vs cash later from HomeDotCom. Suppliers are interested in higher revenue but because they are unsure about the actual HomeDotCom demand, they don’t want to take the risk of keeping stock for HomeDotCom. If the products don’t sell, the suppliers will have to wait for the new season and sell at a discount while bearing the storage cost, - and in the end, maybe lose money. Hence, they choose to sell to big box retailers early, so that they could reinvest the cash received in their business.
3. Lead times. It takes suppliers 30 to 60 days to replenish their stock and many of them reject the idea of replenishment for the “slow season” because they don’t have enough trust in HomeDotCom’s demand curve.
4. By selling wholesale to Home Depot and other big box retailers, suppliers eliminate the logistical headache of shipping the individual products to customers (in case of drop-shipping) or in smaller volumes to HomeDotCom.

OVERALL APPROACH

To help resolve the challenges and satisfy supplier interests, the solutions must address the problems above and provide additional value to the supplier’s business which other big retailers can’t or don’t offer yet. 

TRUST

Trust is the foundation of any productive collaboration. It is the number one goal of the company to establish trusted relationships with its suppliers. Home Depot (130 M visitors/month to the website) and Lowe’s (75 M visitors/month) sell both offline and online with outdoor décor items available in both channels. Both of them have super strong offline presence and sales. HomeDotCom is significantly smaller online and doesn’t have offline presence. Given the scale at which its competitors operate, it may be hard to convince the suppliers that the demand curve is indeed different from what the suppliers are being told by big box retailers. The following information would help us better understand the suppliers’ position (this information can be sourced during supplier meetings):

1. What kind of relationship (personal/professional, close/distant) do HomeDotCom competitors have with suppliers?
2. Is there any exclusivity in their relationships?
3. What data do HomeDotCom competitors share with suppliers?
4. How well the suppliers are supported by HomeDotCom competitors’ category management and customer support groups?
5. Do HomeDotCom competitors ever go out of stock, how often, why and what do they do about it, what happens with their sales after August and before March? If they go out of stock too, how do they work with suppliers to ensure product availability?
6. If competitors go out of stock too, can the lack of inventory be a market-wide problem or is it only HomeDotCom-specific?

All the businesses are managed by people, thus, close personal relationship with the suppliers is extremely important to build trust with them. We would take the following steps here:

1. Regularly meet suppliers in person, on the phone and video calls.
2. Regularly provide them with the category data as tracked by HomeDotCom (sales dynamic, demand, inventory levels, out of stock, inventory turns, excess stock data).
3. Offer to provide analytical data about who the supplier customers are on the HomeDotCom websites. Home Depot and others might not offer this yet and might not have the individual approach to the suppliers. HomeDotCom, given its smaller size and technology, can offer insights into its data analytics to win trust and establish relationships on a personal level.
4. HomeDotCom must position itself as a company whose major objective is to increase supplier’s revenue and grow their business. Given that the company already puts a lot of emphasis on this aspect and members of at multiple teams meet with the suppliers during trade shows, they should be able to communicate this concept well.
5. Trust is often formed when the partners go through good and difficult times together. How HomeDotCom handles difficult conversations, whether the teams are being honest and transparent, whether they keep suppliers’ and customers’ interests in mind will define the HomeDotCom’s long-term success with its partners.
6. When discussing the HomeDotCom demand curve with the suppliers, they will be more inclined to trust the information if they already have had successful collaboration on all the above.

FINANCIAL CONSIDERATIONS

Many suppliers in the Outdoor Décor category have very capital-intensive business. Thus, they will be focused on selling and getting paid faster. We should try and collect the following information which may help HomeDotCom better understand and meet suppliers’ interests:

1. What’s the range of prices in the Outdoor Décor category? What’s the average order value?
2. What are the financial terms of supplier-competitor relationships? When are suppliers paid? What are the discounts Home Depot and others receive as compared with the actual revenue the supplier would receive by selling through HomeDotCom? Any other financial terms or considerations?
3. Do competitors buy only specific best-selling products or do they buy all the stock?
4. Who pays for shipping products to competitors’ warehouses? What kind of operational burden does it put on supplier’s staff (relabeling, repackaging, etc.)?
5. Do suppliers even ship the products to competitors’ warehouses or do they keep some of the stock in their own facilities? Who pays for storage if the products are shipped to competitors? If the supplier pays, what are the financial terms?
6. What are the terms the suppliers have with the manufacturers?
7. What are the financial terms of shipping and storing supplier’s stock at HomeDotCom facilities?

Because HomeDotCom is trying to establish long-lasting relationships and trust with suppliers (and is competing against stronger competitors), we would suggest to consider sharing the risks with the suppliers (while also sharing the successes), at least in the beginning of the relationship. Each of the following recommendations should be very carefully modeled to avoid any unexpected losses:

1. After HomeDotCom gets the understanding of the supplier terms with its competitors, a financial model should be built to project the potential revenue from meeting 100% of HomeDotCom demand. The model should include the DCF analysis to address the cash-now-vs-cash-later issue and ideally show a significant upside for the supplier.
2. To further establish trust and prove that HomeDotCom is “in it to win it” with the supplier, we would consider revenue share in the future, maybe even on more favorable terms for the supplier than HomeDotCom usually does.
3. HomeDotCom may consider buying supplier stock at the end of the season at a pre-agreed price to eliminate the supplier’s risk of excess inventory (if HomeDotCom is confident they will be able to sell it all).
4. If HomeDotCom has data proving sufficient demand for Outdoor Décor products and is confident in these numbers, HomeDotCom may want to guarantee certain amount of revenue to the suppliers (and maybe keep the upside).
5. HomeDotCom might consider co-investing in inventory together with the supplier under the condition of getting more favorable terms in the future (guaranteed stock, better margins, etc.)
6. In the agreement with the suppliers we would suggest to specify the supplier’s responsibility for not keeping enough inventory to cover the pre-determined HomeDotCom demand. 

LEAD TIMES

Close inventory monitoring, reliable demand forecasts and understanding of the supplier’s supply chain organization should help achieve more efficient replenishment. Having established trust and having negotiated the financial terms, HomeDotCom can get more efficiently involved in demand planning and inventory management and reorder at the right time, while maintaining the required levels of safety stock. If we already have trust with suppliers, we eliminate the problem of the suppliers’ hesitance to reorder. We would further explore if there is an opportunity to use HomeDotCom supply chain capabilities to decrease the supplier costs and to speed up the shipping of products from the suppliers’ manufacturers’ locations. We would also try and search for alternative sources of inventory (new suppliers, direct manufacturer’s relationships) to minimize the risk of running out of stock.

If we are facing the challenge of going out of stock, another way to speed up the delivery is to ship it faster and give up some margin. In the end, it is more important to have the product available and sell it at a lower margin than be out of stock and lose the customer. A more detailed margin and LTV analysis will be required to understand what the minimum level of margin HomeDotCom needs to maintain to ensure product availability and company profitability.

LOGISTICAL BURDEN

Suppliers may be more comfortable shipping wholesale to Home Depot and other competitors, especially if they buy their entire available inventory. With HomeDotCom, they will either have to ship individual orders or smaller quantities of products. To eliminate the logistical hassle and level the playing field, HomeDotCom may consider keeping the supplier’s stock at its facilities at no charge for the supplier, in exchange for more favorable terms. Here it would be useful to know the terms of shipping and storing at Home Depot and other competitors, as this information may play significant role in how HomeDotCom structures the deal with the suppliers.

OTHER OPERATIONAL ISSUES

If the supplier’s stock is stored at HomeDotCom’s facilities, the internal logistical teams can take care of customer returns. Suppliers usually don’t like to handle customer service requests and process returns as these processes slow their operations down. HomeDotCom can take care of these issues for the suppliers and thus allow them to focus on their core business: manufacturing and importing the products that will scale their (and, by extension, HomeDotCom’s) business.

ADDITIONAL SUPPLIER BENEFITS

HomeDotCom is a technology-driven organization and, as such, it may be ahead of its larger and more cash-rich competitors. HomeDotCom should use its technological strength to provide additional value to the suppliers. By doing so, it can establish better trust and a stronger foundation for collaboration with suppliers. Additional value can be provided to the suppliers in the following ways:

1. Sharing demand forecasts and segmenting the demand (and sales data) by customer groups, geographic regions and other criteria.
2. Sharing sales data and being transparent about the costs it takes HomeDotCom to move the suppliers’ products. Suppliers are very interested in understanding their target audience, so that they could sell more. Thus, being open and sharing information with them would help both parties.
3. Giving the suppliers access (via API) to the inventory management system.
4. If HomeDotCom and a supplier have a drop-shipping agreement, software integration with the supplier is necessary to ensure full inventory visibility.
5. HomeDotCom could discuss creating advertising opportunities for suppliers on the HomeDotCom websites. This will require significant IT involvement but could potentially drive more revenue for HomeDotCom and build up supplier loyalty.
6. HomeDotCom could provide better marketing support to the suppliers who keep their stock at HomeDotCom’s facilities (such support may include email campaigns, promotion on the website, SEM, SEO, SMM, affiliate, in-app promotions and other opportunities). By providing stronger promotion opportunities to those who are using HomeDotCom’s facilities, it can incentivize those suppliers who have not provided their stock to HomeDotCom yet.

SCALING SUPPLIER RELATIONSHIPS

HomeDotCom has thousands of suppliers in the Outdoor Décor category with few people to manage them. HomeDotCom should create the environment which would allow suppliers to feel strong personal connection with people at HomeDotCom and at the same time allow it to scale beyond one-on-one communication. Below are several ways HomeDotCom can achieve that.

1. Automate sales reports, inventory level reports, replenishment requests, invoicing and other processes, so that HomeDotCom would have no, or very limited, human involvement in them. The reports should come in the customized form for every supplier. This should be relatively easy to achieve given the strong technological base of HomeDotCom.
2. Software integration with those suppliers who work with HomeDotCom on a drop-shipping basis might be very beneficial but difficult to achieve as many of the suppliers are not technically advanced and sophisticated. Further investigation of the types of inventory management systems that they use should be done to understand if there is any potential in building an API to connect their systems with HomeDotCom’s.
3. Organize monthly conference calls (with all suppliers in this category being invited) with people from other HomeDotCom teams actively participating to discuss the company strategy, sales and demand dynamics, and any other problems or issues the suppliers would like to address. Launch weekly/monthly email newsletter.
4. Individual calls with suppliers at least once every few months, in-person meetings, as situation may require, and active trade show participation will establish stronger relationships. In fact, HomeDotCom could even launch its own HomeDotCom-sponsored trade show or conference.
5. Develop several templates for presentations and automate legal documentation generation depending on the terms agreed upon with the suppliers. This requires simple coding and can be done by a programmer.

FINAL THOUGHTS

Every partnership is only as strong as the relationship between people managing the business. To ensure HomeDotCom’s company success, it must ensure constant product availability. If a product is not available on the website or in its warehouse (or in the supplier’s warehouse ready to ship to the customers), HomeDotCom will advertise for its competitors and the customer may never come back to them. Thus, strong supplier relationships are a very important component of the successful marketplace business model and it takes time and effort to build the required level of trust. We believe that if HomeDotCom follows the above-described framework, it can be very successful with establishing long-term partnerships with its suppliers and ensuring large product selection and product availability.

How do you solve product availability and out-of-stock situations at your company?

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