Factory Gate Pricing

Factory gate pricing could change the line of responsibility.

Factory gate pricing is a supply chain initiative that has been gaining popularity among retailers in England. It is now poised to make a leap to this side of the Atlantic Ocean. Essentially, with factory gate pricing (FGP), retailers buy goods at the suppliers' "gate" and take care of getting it to their stores or distribution centers, either with their own trucks or those of their contracted carriers. It removes transportation costs from the overall price that retailers pay for the goods that they will eventually sell in their stores.

For retailers, factory gate pricing could generate "significant" savings on delivery costs and the number of transport miles, says John Murphy, director of product marketing at Global Logistics Technologies Inc. (G-Log), Shelton, CT, a software provider that has worked with several European retailers in refining transportation management to better handle factory gate pricing.

New York accounting firm PricewaterhouseCoopers, one of many financial analysts that has been watching factory gate pricing initiatives, estimates that it could generate savings of 20 percent on delivery costs.

Those savings become increasingly important as transportation costs continue to rise. According to the latest statistics from the Food Marketing Institute, during the late 1980s, some two-thirds of logistics costs were related to warehousing, and about a third was tied to transport. Today, transport costs account for more than half of a company's logistics expenses, and costs are expected to continue to climb as fuel costs continue to reach record highs.

Potentially, FGP allows retailers to drive down the cost of goods by removing the transportation element from them. It also lowers the risk of potential price increases due to fuel cost increases, driver shortages and decreased capacity.

Factory gate pricing "is about improving transportation efficiencies by understanding the true costs," according to the United Kingdom's Institute of Grocery Distribution (IGD), in Hertfordshire, England. "Suppliers who are highly skilled and cost-efficient at providing transport solutions will continue to provide this service to the retailer. Suppliers who do not see transport as their core competency, or do not have highly efficient operations, have an opportunity, through FGP, to transfer the responsibility to the retailer or logistics provider."

Tesco Leads The Way

English grocery chain Tesco was the first retailer to implement factory gate pricing back in the fall of 2001. The retailer, which operates 759 stores offering 50,000 product lines, handles more than 1 million inbound shipments per year from more than 2,500 suppliers. By 2003, it had factory gate pricing procedures in place with 500 suppliers, and by 2004, those numbers had doubled. Currently, as much as 90 percent of its frozen inventory and more than half of its total inventory arrive at the retailer's facilities by some kind of factory gate pricing program.

For Tesco, factory gate pricing has allowed it to reduce costs by more than 10 percent. Other benefits, beyond saving millions in transportation costs, have included a 14 percent improvement in on-time deliveries, a reduction in transport miles and greater supply chain visibility. Visibility, the retailer has found, comes from a greater awareness of orders being placed by individual stores within its network, and greater insight into where costs are coming from.

"Tesco led the way and a lot of folks are realizing that it makes more sense for them too," Murphy says. "Tesco is a good impetus for change. They are leaders in Europe, and if they can do this, it makes others stand up and take notice."

Other British retailers that have implemented factory gate pricing initiatives include Asda, Wal-Mart's U.K. subsidiary operating 265 stores and 19 distribution centers, and J. Sainsbury, which operates almost 600 supermarkets and 160 convenience stores across the United Kingdom. Fellow retailers Somerfield, Safeway, Morrisons and Waitrose are also exploring their factory gate pricing options, and in Spain, Carrefour is experimenting with it among 45 of its suppliers.

Already in the United States, some large retailers, including JC Penney, Family Dollar Stores, The Gap and Toys 'R' Us, have also been experimenting with factory gate pricing. JC Penney alone reportedly saved between $8 million and $12 million the first year, with only a small percentage—about 10 percent—of its suppliers participating.

Market research firm Datamonitor, based in London and New York, predicts that factory gate pricing "is set to continue and gather pace as more retailers adopt the system. As the retailers who have led the way in factory gate pricing realize considerable cost savings and supply chain efficiencies, and hence gain competitive advantage, their rivals will seek to close this gap by following suit."

G-Log's Murphy agrees. "Everyone is dipping their toes in the water right now, and I suspect that in about 18 months we will start seeing everyone talking more about it and looking at logistics holistically," he says.

Whether it's in the U.K. or the U.S., "I believe the driving forces are the same. In general, companies want to take control of their inbound shipments to reduce costs and improve productivity via better optimized pick-ups and deliveries and better receiving schedules and processes at the distribution center," says Adrian Gonzalez, director of the Logistics Executive Council and a supply chain management consultant at ARC Advisory Group, Dedham, MA.

Slow Start In U.S.

So why has it not advanced further in this country? Analysts say that corporate organization has hindered factory gate pricing.

"Companies have historically focused on their outbound operations because it's the customer-facing side of the business, while control of inbound operations was generally relinquished to suppliers," Gonzalez observes.

As a result, many companies have re-signed themselves to the general practice of pre-paying for transportation charges as part of purchasing agreements, Gonzalez continues. "Purchasing managers generally have limited knowledge of transportation. Therefore, purchasing managers generally ask vendors to quote landed cost or all-inclusive prices.

"This lack of control and visibility results in higher transportation costs, lost revenue, diminished customer satisfaction, higher overhead costs and lower productivity," he says.

Trying to overcome this mindset is no easy task, either. "One of the challenges for factory gate pricing, regardless of country, is resistance from the purchasing organization. Factory gate pricing forces them to renegotiate and re-establish contracts with vendors," says Gonzalez.

"Within organizations in the U.S., it often is the case that the buying organization and the transportation organization do not have the same objectives," G-Log's Murphy says. "The buying organization is not concerned with transportation—that is the job of the transportation department, and vice versa.

"When we go to organizations, many are struggling with the idea of transportation and purchasing working so closely. You can make the same argument on outbound and inventory control," he continues. "That's where change management and the way of handling inbound [shipments] have to be looked at from an organizational standpoint. They need to look at transportation, the cost of the items and all that together holistically within the company."

"Companies where logistics and purchasing report to the same executive have been the most successful in converting from pre-pay to collect freight," says ARC's Gonzalez.

Obstacles To Overcome

Factory gate pricing, Murphy adds, "needs vendors, buyers and suppliers all involved to make it work."

But, vendors have been the largest impediment to widespread implementation of factory gate pricing, according to ARC's Gonzalez. Among their concerns, he says, are:

  • A loss of margin, as they will not be able to mark up freight charges to in'-crease revenue;
  • A disruption to warehouse operations, by having to wait for customers to pick up their products and to provide additional handling to prepare the items for pick up;
  • More expensive transportation costs on their end as their shipping volumes decline;
  • A roll-back of efforts they've already made to streamline inbound and outbound operations; and
  • Uncertainty about new initiatives retailers may pursue next, such as taking control of packaging.

In some cases, retailers may not want to adopt factory gate pricing, either, the experts warn. "Taking 100 percent control of all inbound shipments may not always be the best situation. There may be cases (i.e. certain lanes or geographies) where having the vendor maintain control is the best option because they may be able to obtain better rates or service," Gonzalez says.

"Supplier control over transportation and distribution will continue to be reduced. Retailers' power as employers of transport logistics will be increased," Datamonitor predicts.

According to Datamonitor, logistics companies stand to gain the most from factory gate pricing. "There are opportunities for logistics companies that can add substantial value for retailers, and help them reduce supply chain costs. Those with more geographical coverage and global retail supply chain expertise will be in demand by those retailers seeking to control their overseas-sourced products from the factory gate," the firm concludes.

DSD, FGP: Complementary, Not Competitive

While many argue that factory gate pricing will spell the end of direct store delivery, that is not the case, according to many experts who have followed both trends.

"For food companies, there are lots of opportunities for factory gate pricing. You can take it one step beyond in that you can skip the DC and bring it right to the stores," notes John Murphy, director of product marketing at software provider G-Log, based in Shelton, CT. In fact, "it allows Tesco to do more DSD. Things can be consolidated in one truck to go directly to the store. You can pick up Coke at one location and bread at another, load them both onto one truck and take them straight to the store with DSD."

"DSD is still relevant, because it relates to getting goods into the store, not from the manufacturer," adds Richard Kochersperger, director of the Food Marketing Group in Wallingford, PA, and a professor of food marketing at St. Joseph's University in Philadelphia.

And, for retailers frustrated with DSD, factory gate pricing can eliminate many of the problems associated with it, Kochersperger adds. "Stores can get the items more cheaply and they do not have to have guys running all over their store and trucks all over their yards, receipts all over their docks, etc."

"If I were a retailer, I would do it in a heartbeat," he says. "I would want to be able to control every aspect of my business and would not want the manufacturer to control the transportation costs for my goods. I would want to control every movement of goods into my facilities."