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Julieta Mendes Lima | Business Consultant | everis Brazil

Centralized Distribution Model: Understanding What’s at Stake

Should I move to a centralized distribution model? I imagine, as a logistics manager in the consumer goods industry, you have asked yourself that question, or been asked by someone to make that decision. Have you ever stopped to consider the impacts this decision could have on your whole supply chain?

Although it has been discussed in the market, centralized distribution has grown in importance to the logistics areas of consumer goods companies, for both the industrial (supply) side and the wholesale and retail chains side (clients).

Deciding to centralize distribution will impact every step of a company’s supply chain. Using the SCOR (Supply Chain Operations Reference) model as a reference point — considering its approach to structuring a segmented supply chain using five macro-processes: Plan, Source, Make, Deliver, and Return — the largest impacts will be on Delivery, the stage that contains the routines related to delivering a product to its destination.

However, to make this decision, you need to understand what centralized distribution models are. These models are characterized by delivery to locations that have been chosen in advance by the client. These locations are the major hubs for receiving merchandise, known as Distribution Centers (DCs), leaving the client with the responsibility to deliver and ensure that products reach final consumers in the right quantity, with the right quality, at the right time, and in the right place.

In contrast, the decentralized distribution model aims to meet the client’s need at each of their points of sale (POS), following the same requirements, in the right quantity, with the right quality, at the right time, and in the right place.

To illustrate the importance of this issue, a major Brazilian beverage company uses a hybrid distribution approach, in which some clients use centralized distribution and others use decentralized distribution. Although fewer clients (about 60 clients among hundreds) use a centralized distribution account for about 50% of the company’s total revenue.

You may be asking yourself why there is such emphasis on centralized models now. There are two main reasons:

· Changes in consumer behavior. With the growth of online sales (according to recent studies, more than 100 million Brazilians are internet users, and 19% research or make purchases online), retail competitors do not need to worry about depending on a physical point of sale. Exclusive online competitors are found in every category of products. In other words, it is possible to meet the needs of consumers anywhere in Brazil using a single DC.

· The strong influence of wholesale and retail chains over end consumers: Despite the trends in consumer behavior, physical stores remain the main sales channel for many businesses. According to Forbes, i-SCOOP and everis Analysis, 90% of retailers’ transactions happen in physical stores. Wholesale and retail chains claim to influence the consumer market, and their importance to the consumer goods industry, and have begun to demand benefits from the sector.

In this context, the consumer goods industry has come under pressure to give in to centralized distribution, and pay the chains for their work making delivery to POSs. In principle, and without wanting to stress the subject, this practice is a good way to reduce the operational cost of delivery. However, it is important to dive more deeply into the variables impacted by this distribution model, and determine whether centralized distribution is viable and, if so, understand the extent to which that is the case.

In order to answer these questions, the first step is to identify the variables that impact the industry when they adopt centralized distribution, then to analyze and verify whether they can be measured, to create a precise understanding of the “optimal” point at which this model can be considered viable.

Seven key points, based on an analysis of the Brazilian context for consumer goods companies and their clients, are:

  1. Operational logistics costs: Assuming products will be delivered to a single location, the operational costs of delivery tend to fall significantly, but it is important to consider all costs to build a clear view. Costs include: shipping, storage, fleet maintenance, circulating assets involved in distribution, etc.
  2. Time dedicated to delivery: It is generally simpler and faster to manage high-volume deliveries to a few locations, compared to the dispersed delivery of small volumes to many POSs. Measuring gains involves parameters such as: distance among factories, distribution centers (for industry and the client), and POSs; number of POSs covered by each DC; mean time dedicated to each delivery, etc.
  3. Service level: It is important to consider issues related to the satisfaction of the end customer. In other words, you must consider variables that show that products are reaching end users with the necessary quality and at the right time. In this case, you might analyze: on-time deliveries, volume of product returns, etc.
  4. Volume sold: In the centralized distribution model, chains generally buy a large volume of product to stock their DCs, then their POSs, in order to maintain a stock level that reliably allows them to fulfill distribution routines. In this case, you can consider the volume and frequency of orders.

It is important to emphasize that this does not necessarily mean an increase in sales volume for the industry. Rather, sales are concentrated in larger lots. This should be taken into consideration because it requires better planning and control of production.

  1. Fiscal issues: Fiscal issues should be considered, to evaluate the tax burden on changing the delivery logistics network. This variable can be obtained using the geolocation of factories and delivery sites, and understanding the tax regime in each location.
  2. Product availability: When industry delegates responsibility for POS distribution to retail chains, it also delegates part of its control over the availability of its products to the end consumer, which means a partial loss of visibility of demands per POS. This can be managed using out-of-stock indicators.

7. Quality of products offers to end customers: When industry actors stop supplying POSs, they also lose control over delivery conditions. In this case, you can consider metrics such as product returns and customer complaints.

It is important to highlight that some of these issues can also impact the brand, and therefore, the consumption of the product. With respect to these issues, we seek to understand the opportunity cost that industry actors face when they outsource the distribution of their products.

With this information in hand, consumer goods industry actors can determine whether it is worthwhile to service wholesale and retail chains using a centralized model.

Considering how many variables exist to analyze and manage, why are these chains so interested in centralization? We could say that this is not a sensible decision, because they take on a process (distribution to POSs) that is not a core activity, and one that requires large investments in the required logistics infrastructure.

Chains are motivated by the demand of consumer goods industry actors, their suppliers, compensation for taking on the delivery process (deliver to POSs), but they also add a margin to this amount to subsidize the necessary investments.

In Brazil, this compensation is usually defined without the support of pre-established parameters, and it is not unusual to see informal agreements. The negotiation is usually conducted informally between the commercial areas of industrial actors and the purchasing and/or logistics areas of retail chains, which agree to an amount after a negotiation without actually knowing whether it is viable.

Other means of defraying costs are also discussed by both parties, but the agreements are often broken by one side or the other and in the absence of formal agreements, they are not penalized, reducing the relevance of these agreements.

The challenge faced by commercial goods industry actors is building a logistical model for decision-making, with a mechanism to support their negotiations, so they can make coherent decisions, and establishes the necessary formal mechanisms to ensure control over any logistical agreements they make.

At everis Business Consulting, we have worked on projects that deal with these issues, and are available to help you build a logistical model that helps attain the best possible outcome from negotiations.

The Distribution Models Decision is part of the everis Operations Value Proposition — Supply Chain Management, which has conducted many local and global projects.

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