Zappos com developing a supply chain to deliver wow

“Zappos.Com: Developing A Supply Chain To Deliver Wow”;

Relevant case studies will be introduced throughout the quarter to facilitate a comprehensive understanding of a specific supply chain concept as it relates to real world situations. Students will be required to appraise, evaluate and determine an appropriate solution for a designated organization based both on the case study and outside research. They will present their conclusions in class along with the requisite discussion of how their determination was made. An accompanying 4 to 6 page double spaced paper describing and elaborating on the case study findings is also required.

Identify and evaluate the case determining key issues, critical players and the overall supply chain problems facing the organization. Determine an appropriate solution to the problem justifying your position with necessary facts and analysis

David Hoyt prepared this case under the supervision of Michael Marks, Lecturer in Operations, Information, and Technology, and Professor Hau Lee as the basis for class discussion rather than to illustrate either effective or ineffective handling of an administrative situation. Copyright © 2011 by the Board of Trustees of the Leland Stanford Junior University. All rights reserved. To order copies or request permission to reproduce materials, e-mail the Case Writing Office at: cwo@gsb.stanford.edu or write: Case Writing Office, Stanford Graduate School of Business, 518 Memorial Way, Stanford University, Stanford, CA 94305-5015. 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 the Stanford Graduate School of Business.

ZAPPOS.COM: DEVELOPING A SUPPLY CHAIN TO DELIVER WOW!

Our decision was always to focus on service because we got instant feedback whenever we upgraded delivery. Customers were wowed by the experience, and then they told a bunch of people. And word of mouth works a lot faster on the Internet than it does person-to-person because you can just e-mail out a bunch of your friends and say, 'hey I just had this amazing experience.' That was one of the reasons that we wanted to keep upgrading shipping.

—Alfred Lin, Chairman, COO, and CFO of Zappos1

In late 2008, less than 10 years after its founding, Zappos anticipated reaching annual gross sales of $1 billion. When its founder first proposed the idea of selling shoes online, the concept was greeted with intense skepticism. Despite the challenges, the company had achieved dramatic success. It was the world’s largest online retailer of shoes, was profitable, growing rapidly, and had an outstanding reputation for customer service. Its employees were passionately, engaged in their work. While shoes still provided the vast majority of revenues, Zappos had expanded its product offerings based on feedback from customers and the enthusiasm of employees. There was still a huge untapped customer base—only 3 percent of the U.S. population were Zappos customers—suggesting that the company was not close to saturating its opportunities in the U.S., let alone other international regions. However, the collapse of the financial markets, and the prospect of a prolonged recession, created new challenges. Zappos had never been lavishly funded—it had always been intensely conscious of cash. Unlike most retailers, it was continuing to grow, but early signs were that the rate of growth was slowing. As the company’s leadership looked forward, it considered ways that Zappos could sustain the high quality experience that it was known for—to deliver “wow” to its customers, suppliers, and other affiliates. The company’s supply chain management had evolved as Zappos had grown, and was one of its sources of excellence. Yet, perhaps there were opportunities for continued improvement.

1 Quotations are from interviews with the author, unless otherwise specified.

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ZAPPOS.COM

In 1999, Nick Swinmurn was frustrated in finding the right size, color, and style of shoe. After trying several stores, he felt there must be a better way. Stores carried a relatively small selection of styles, and usually did not have a full complement of colors and sizes even for the styles they did stock. This was not surprising considering the physical constraints of shoe stores, the limited number of shoes that an average store could stock, and the small local population served by individual stores. But this was 1999, and the Internet boom was in full swing. If Swinmurn, who was an ordinary shoe customer (not a shoe fanatic), was frustrated, it seemed likely that many others must be feeling the same way. What consumers needed was a way to access a huge selection of styles, colors, and sizes. Since none existed, Swinmurn decided to create one, using the Internet to address the selection problems faced by traditional shoe retailers—despite having no experience in retail, let alone the shoe industry.

Raising Capital

Swinmurn raised $150,000 from family and friends and recruited Fred Mossler, a senior shoe buyer at Nordstrom, to join him. Swinmurn tried to raise venture capital, but had difficulty finding investors willing to put in large amounts of money. One of the venture firms that he approached was Venture Frogs, founded by Tony Hsieh and Alfred Lin. Hsieh was a young Harvard graduate, who had cofounded an Internet advertising firm called Link Exchange with Sanjay Madan, a college roommate. They sold the company to Microsoft for $265 million in 1998, when Hsieh was 24. Lin had been a friend of Hsieh’s at Harvard (and a customer of Hsieh and Madan’s college pizza-making business), who left a PhD program at Stanford University to join Hsieh at Link Exchange. Hsieh and Lin then founded Venture Frogs, which funded Internet start-ups, including companies such as AskJeeves, Tellme Networks, and Zappos. In 1999, at the height of the Internet boom, Swinmurn left a voicemail with Venture Frogs, explaining that he had started a company to sell shoes on the Internet. As Hsieh and Lin were about to hit the delete button, thinking that this “sounded like the poster child for bad Internet business ideas,”2 Swinmurn said that the shoe market in the United States was $40 billion, and that 5 percent of this business was being done by mail order. Hsieh and Lin realized that if people bought $2 billion of shoes from catalogs, the Internet—with its capacity to reach large sections of the population and to provide detailed information vastly better than a catalog could—was going to be a substantially larger market. They decided to invest, putting about $2 million into the company over the next few years. Hsieh also invested personally in Zappos (whose name was an adaptation of the Spanish word for shoes, “zapatos”). Later, Sequoia Capital, a premier Silicon Valley venture firm, also invested in the company. While Hsieh, Venture Frogs, and Sequoia put money into the company, Zappos was never funded on the lavish scale of Internet start-ups such as WebVan—the total investment in the 2 Hsieh quoted in Duff McDonald, “Sole Purpose,” CIO Insight, November 2006, p. 45.

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company was less than $10 million for the first five years of the company’s existence. Sequoia Capital would later lead an investment round of $54 million, some of which was used to buy out early investors. In the long run, the lack of substantial funding was a benefit—Zappos was forced to focus on those factors which were essential to success, operate efficiently, and avoid the excesses that led to failure for many other Internet start-ups. The difficult challenge of creating a successful online shoe retailer, which inhibited access to large-scale investment, had another advantage—lack of competition. As Lin said, “It was actually tempting to invest in a company where everyone thought this couldn’t be done, because you knew that in the early stages, you were not going to have a lot of competition.” However, in the short run the relatively low funding raised by the company was painful—there were times when employees worked for months without paychecks in order to help the company survive.

Financial Success

After investing, Hsieh began to work closely with Swinmurn, and in 2000 they became co- CEOs. Lin joined as CFO in 2005, later adding the roles of COO and chairman. Swinmurn left Zappos in 2006, and Hsieh became the sole CEO. Zappos had strong growth from its first sales through 2008, when it expected gross merchandise sales of $1 billion (Exhibit 1). This strong growth was largely dependent on a happy, loyal customer base. As the company developed, the percentage of repeat customers grew—from 40 percent in 20043 to 75 percent in 2008.4 Hsieh viewed this as essential for sustained success, saying, “You can get anyone to buy from you once…. The hard part is getting people to buy from you again and again.”5 Zappos became profitable in 2006, but did not have an objective of maximizing profit, preferring to invest in growing the company. That year, Zappos was able to achieve gross margins of 31 percent, even after shipping and returns (with more than one in four orders returned).6 Shipping, both outbound and for returns, was a substantial part of the company’s cost structure, at about $100 million,7 or almost 17 percent of the company’s gross sales of $597 million in 2006. This percentage had remained relatively constant over time, despite increasing return levels and decreasing delivery times. In late 2008, Zappos had about 9 million customers—a large number, but just 3 percent of the U.S. population, leaving plenty of room for continued growth. It had about 1,500 employees, half in its Nevada headquarters and call center, and half in its Kentucky fulfillment center. The company was still private, with no immediate plans for an IPO.

3 Richard Waters, “Trial and Error Shows the Path to Success,” The Financial Times, March 9, 2005, p. 9. Zappos defined repeat customers as any customer that had previously purchased from the company. 4 Jeff Morris, “Service a ‘Shoe-In’ for Zappos.com,” Multichannel Merchant, April 2008, p. 7. 5 Arthur Zaczkiewicz, “Zappos Sells Service,” Women’s Wear Daily, November 15, 2006, p. 24. 6 Waters, loc. cit. 7 Sidra Durst, “Shoe In,” Business 2.0, December 2006, p. 54.

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Corporate Culture and Values

Zappos had a strong company culture, which was developed and nurtured by management. This culture, together with company values, was a strong influence on all aspects of the business, including the supply chain. Hsieh and Lin recalled that the strong culture that existed in the early days of their first start-up, Link Exchange, had disappeared as the company grew. As Lin explained, “At the end of the day, one of the reasons we sold the company was because it was no longer a fun place to work.” They were determined that this would not happen at Zappos. As a result, when Zappos leadership considered what it needed in order to meet the next year’s business objectives, the question “How are we going to grow the culture?” was as important as issues such as “How many people do we need to hire, how many more servers, or how much more office space do we need?” Hsieh described what the culture meant to him in 2008:

To me, the Zappos culture embodies many different elements. It’s about always looking for new ways to WOW everyone we come in contact with. It’s about building relationships where we treat each other like family. It’s about teamwork and having fun and not taking ourselves too seriously. It’s about growth, both personal and professional. It’s about achieving the impossible with fewer people. It’s about openness, taking risks, and not being afraid to make mistakes. But most of all, it’s about having faith that if we do the right thing, then in the long run we will succeed and build something great.8

Hiring and training were particularly important in maintaining and growing the culture and the company’s values. Hsieh said, “We want people who are passionate about what Zappos is about—service. I don’t care if they’re passionate about shoes.”9 (Zappos’ culture and values are discussed in detail in the Appendix.)

THE ZAPPOS SHOPPING EXPERIENCE

From the beginning, Zappos set out to provide an exceptional shopping experience for its customers. It wanted customers, after any interaction with the company, to say “Wow!” To illustrate the priority placed on serving its customers, Hsieh referred to Zappos as “a service company that sells shoes,” which he later amended to include the wide range of other products sold by the company. Hsieh elaborated on the importance of customer service: “It’s not really a secret…. People have known for a long time that companies that provide good service do really well. Yet no one does it.”10 Hsieh saw customer service as an investment rather than an expense.

8 “2008 Culture Book,” Zappos.com, p. 12. 9 Christopher Gergen and Gregg Vanourek, “Zappos Culture Sows Spirit,” The Washington Times, July 16, 2008, p. B2. 10 Waters, loc. cit.

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The drive to provide a “wow experience” informed every aspect of the company. The Zappos website loaded faster than any other retail website. While most orders were made online, telephone support was essential for maximizing the customer experience. Unlike other popular retail sites, he company’s toll-free phone number was prominently displayed on all its web pages, the average phone call was answered in less than 20 seconds, and call center operators had the authority to resolve virtually any issue. Zappos knew that its primary competition in the shoe business was brick-and-mortar stores, and that in order to be successful, customers needed to be comfortable buying shoes online. The company addressed this challenge in a number of ways, including free returns, providing extensive online product information, maintaining a call center, and free overnight shipping.

Fit, and the Return Policy

A key aspect of making customers willing to buy shoes online was dealing with the issue of fit— customers needed to feel comfortable that they would receive products that fit, and that they could return those that did not. Zappos quickly realized that this could be best addressed by providing free returns, initially for 60 days, later extended to 365 days (although most returns came back within 60 days). Customers could thus purchase several pairs of shoes, of different styles and fits, keeping those they wanted while returning those that did not fit. Zappos closely monitored customer behavior. It found that the most profitable customers were not those that returned the fewest products. Customers who made use of the free return policy tended to experiment with different brands and styles—while they had a higher return rate, they also made more net purchases. Overall, returns were about 35 percent of gross sales.

Online Product Information

It was also essential to provide as much information as possible to customers as they made their purchasing decisions. This was done in several ways. Retail websites typically had small photographs of products, with swatches of the available colors. The pictures were generally from only a few angles, and often did not show important details. Zappos provided substantially better information to customers. When new models (or models with new colors) arrived at the Zappos warehouse, a photography team took pictures from several angles (by 2008, eight photos were taken of each style and color). Customers interested in a particular item could easily see large pictures, in the desired color, from multiple perspectives. The site also included detailed descriptions of the shoes, as well as information that would ordinarily be provided by experts at a brick-and-mortar shoe company. For instance, a person’s gait (the way that they ran or walked) was important in finding the proper running shoe. The Zappos site had a detailed discussion of gait, and how customers could determine which type of shoe was appropriate for them. The site also provided customer feedback. Customers could write comments on the shoes they purchased, which Zappos did not edit (except to remove profanity). The most recent customer comments were displayed for each type of shoe.

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The Zappos Call Center (“Customer Loyalty”)

Most customer interactions were through the website, which handled about 95 percent of orders. The rest of the orders, plus questions about products, returns, or other issues, were handled by the call center. In 2008, this was staffed 24/7 by about 400 people in the Las Vegas headquarters. As described in the Appendix on company culture and values, all Las Vegas employees went through the same 4-week new-hire training course. At the end of the course, regardless of the job that they were hired for, they spent at least two weeks in the call center working with customers. Zappos measured most every aspect of its business, including the call center (or “customer loyalty” in Zappos terms). It measured how long it took from the time a customer called to the time the call was answered by a call center operator—in 2008 this number was astonishingly low, consistently averaging less than 20 seconds. It did not, however, measure call center operators on metrics of efficiency, such as how many calls they took. The objective was to provide the customer with the best possible experience. If that meant having an extensive conversation with a customer about his interest in running, the call center operator was encouraged to have the conversation. If the customer was looking for a specific shoe that was not available at Zappos, the call center operator was trained to look on at least three other Internet websites to find what the customer wanted, and then talk the customer through finding the product on the competitive website. Zappos would lose that order, but the customer would likely return to Zappos in the future. Hsieh commented, “We score [call center operators] based on whether or not they went above and beyond for the customer…. We don’t care if they made the sale or how ‘efficient’ they were…. For us, every interaction is a branding opportunity.”11 One widely cited example of a call center operator going above and beyond customer expectations took place in July 2007. A call center operator was following up on shoes that should have been returned, and e-mailed the customer. The customer replied that she was very sorry—she had bought the shoes for her sick mother, who had since passed away, and had not gotten around to returning the shoes. The call center operator arranged for UPS to go to the customer’s house to pick up the shoes, then sent a flower arrangement and condolence card to the customer. Needless to say, the customer was overwhelmed by this concern on the part of a company, and posted comments about her experience on a blog, which were widely circulated.12 Call center operators were trained to handle most any situation by themselves. They were given the authority to do so using their best judgment without needing to escalate the matter to a supervisor or manager. For quality control purposes, calls were monitored by Zappos employees, not by an outside agency. Monitors listened to ensure that the operator had exceeded customer expectations, and that the customer’s experience had been excellent.

11 Ken Magill, “Workers Paradise: Zappos.com Believes Happier Staffers Lead to Happy Customers,” Direct, October 2007, p. 35. 12 Brian Morrissey, “These Brands Build Community,” Adweek.com, May 12, 2008.

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In late 2008, the call center received about 5,000 calls daily. Zappos viewed each of these as a chance to “wow” a customer in a personal way. As Hsieh said, “At that point, you have the full attention of the customer…. That’s the time where you have a huge opportunity … to shine.”13 A customer that had an exceptional experience was likely to tell friends about it. With the ease of e-mail communication, positive or negative customer experiences could be rapidly spread to large numbers of people. Zappos wanted to ensure that its word-of-mouth testimonials were overwhelmingly positive.

Free, Rapid Delivery

The final aspect of providing exceptional service was rapid delivery at no additional charge. Zappos always tried to beat customer expectations, under-promising and over-delivering. Ultimately, this meant operating the warehouse around the clock, every day, with deliveries made overnight by UPS. An order received in the evening would usually be delivered the next day, even though the standard delivery terms were for UPS Ground, which had a 4-5 day delivery expectation. Lin elaborated:

I guess in the early days we didn't really have a choice; we couldn't afford anything else except ground shipping. Then we started understanding that whatever money we had left over we wanted to reinvest in the growth of the company. We can either spend it on marketing, trying to get new customers, or we can spend it on our existing customers and let them drive the word of mouth, and let them drive the “come back.” You know these customers are going to buy shoes at a later date, so our decision was always to focus on service because we got instant feedback whenever we upgraded someone. They were wowed by the experience, and then they told a bunch of people. And word of mouth works a lot faster on the Internet than it does person-to-person because you can just e-mail out a bunch of your friends and say, 'hey I just got this amazing experience.' So that was one of the reasons that we wanted to keep upgrading shipping. The other reason is that we've always thought about our real competition as the instant gratification you can get walking into a brick-and-mortar store, trying on some stuff, and walking out with the stuff you like. Our idea was that over time, we were going to get as close to that as possible, and that would really bring the store to your home.

During the 2006 holiday season, Zappos guaranteed next-day delivery for all orders, and continued the policy through 2007. However, since customers expected next-day delivery, “they were no longer as wowed as before, when it was a ‘surprise’ upgrade,” according to Lin. Furthermore, guaranteeing next-day delivery set customers up for disappointment on those rare occasions when the delivery was late due to unavoidable problems such as weather impacting plane schedules, or if communications lines were down and Zappos was unable to communicate orders to the warehouse. Overall customer satisfaction decreased very slightly in 2007, and the company decided to no longer advertise overnight delivery. It provided the same level of service, but only guaranteed 5-day ground shipping. Zappos found that when customers no 13 Michael Bush, “Customer Service a Branding Opportunity,” Tire Business, May 12, 2008, p. 35.

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longer expected next-day delivery, they were again surprised when packages arrived the next day, especially when they had placed their orders late at night. As Zappos continued to increase delivery speed, shipping cost as a percentage of net sales (after returns) remained constant, even though the percentage of returns increased. By 2008, Zappos was one of the top three UPS overnight shippers, and worked closely with UPS to increase efficiency and drive down shipping costs. If Zappos decided to back off from its desire to ship all orders for overnight delivery, for instance, using ground delivery for all customers that were within a two-day delivery from its warehouse, it estimated that savings could be significant. UPS estimated UPS Ground could reach 11 percent of Zappos customers within one day, 49 percent within two days, 18 percent within three days, 21 percent within four days, and the remaining 1 percent would take five days.

THE DEVELOPMENT AND EVOLUTION OF ZAPPOS’ OPERATIONS

Zappos began in San Francisco, in the second floor of a Victorian house, with the founder of Craig’s List living downstairs. By 2004, the company needed to expand, with particular emphasis on its call center. Hsieh and the senior management believed that it was important to have the call center as part of corporate headquarters, rather than outsource or remotely locate this function—after all, the company’s primary focus was on providing the very best customer experience, and the call center was central to achieving this objective. The Bay Area was expensive, but it also did not have the right environment, nor access to suitable employees to staff the type of call center that they believed was essential to the company’s success. They decided to move Zappos to Henderson, Nevada, on the outskirts of Las Vegas. Las Vegas was a service-oriented city that operated on a 24-7 schedule, was already home to many call centers, and had extremely good Internet connectivity. Of the 90 employees in San Francisco, 70 moved to Las Vegas.

Attracting Brands

In the early years of the company, it was difficult to get brands to sign up for online distribution. Shoe companies had made huge investments in their brand equity. In 1999, Zappos was an unknown start-up, and established retailers viewed the Internet as, in Mossler’s words, “kind of a flea market…. They saw the Internet as a place where everything would be discounted, and their brand would be ruined.” In addition, the existing retailers pressured the brands to resist online sales, as they did not welcome the new competition. An additional complication was that brands were more successful when grouped—athletic shoe brands, for instance, fared better when grouped with other athletic shoes. If a retailer offered only one athletic shoe brand, there would not be enough selection to attract customers. Thus, it was difficult to convince companies to be the first brand of a category to be carried by Zappos. Once the first brand signed on, however, subsequent brands were easier to attract. In its first year of operation, the company signed up 60 to 70 brands. Zappos focused its attention on signing brands that customers searched for or asked for when talking to call center operators. The company reviewed logs of customer searches for brands that

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were not on its site, and its buyers investigated those brands and evaluated whether they would be valuable additions to the Zappos offering. As the company grew and became well known within the industry, brands began to contact Zappos about being sold through the site. As Steve Hill, the company’s vice president of merchandising in 2008, said, “[The buyer] will get in touch with the brand, talk to them, and look at the product. If there’s a compelling reason to have the product, then we’ll go ahead and open the brand. In a lot of cases, it would be duplication of something we already have, so we may not go down that road.” High-end brands, initially reluctant to partner with online retailers such as Zappos, eventually came on board for several reasons. First, as consumers became comfortable buying online, this became an important distribution channel. Second, they began to realize that if customers could not purchase authentic high-end brands, it made it easier for counterfeiters—customers searching for their brands on the Internet would end up on sites that sold fakes. A third incentive for high-end brands arose when Zappos began creating “vertical” sites within Zappos.com. The first such site, “Couture,” was created in 2003, and featured high-end fashion products (initially shoes, later expanding to clothing and accessories). By 2008, Zappos had added verticals for running, outdoor activities (such as hiking), and a “RideShop” featuring products for skiing, skateboarding, surfing, and off-road bicycling. Brands were eager to participate in vertical sites, since those visiting the sites would be passionate consumers—the types of customers that wanted high-end brands, and that those brands wanted most to attract. As customers were wowed by the company’s high level of service, they began asking Zappos to carry products beyond shoes. Zappos added additional products based on the passion displayed by customers or employees. Lin explained:

A lot of companies look at [product] categories from a market point of view, and chase after big markets—they think a market is strategic and want to go into that market. We have tended to look at things as: ‘if we want to get into this product category, do we have passionate people, whether it’s a customer, or an employee, or a partner, that would love for us to be in that product category?’ It’s actually worked out very well in those situations. So, if customers want us to get into handbags or accessories because we sell shoes, we go into that category.

Zappos began selling electronic entertainment products because some of its employees were passionate gamers, and wanted to sell gaming equipment. Lin observed, “We found that people who are passionate about a product category tend to run it much better and much more efficiently than people who just think, ‘this is a big market, I want to get into that business.’” By late 2008, some of the non-shoe products that Zappos sold included: handbags, luggage, clothing, eyewear, electronics (cameras, computers, video games, phones, and GPS devices), watches, houseware, and jewelry. Its outdoor vertical site also included items such as tents, stoves, water filters, lanterns, and other items important for outdoor enthusiasts—these customers were not just interested in hiking boots, they were passionate about the outdoors, and wanted to be able to get a wide range of products. Other vertical sites included a range of items important to customers interested in those sites areas of focus.

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Evolution of the Operational Model

The original Zappos business model was to provide exceptional product selection by partnering with shoe companies, which would hold the inventory and fulfill orders. Customers would order shoes from the Zappos website,14 and the orders would be forwarded to the shoe companies, which would fulfill the orders. Thus, Zappos would not incur inventory or fulfillment costs. Zappos charged customers the retail price, and paid its vendors the wholesale price. Over time, this model changed, until by 2003, all Zappos shipments were from its own inventory. This evolution was primarily driven by the company’s focus on customer satisfaction.

The Drop-Ship Model The original “drop-ship” approach had two major problems. First, inventory information on the website was only about 95 percent accurate. The company received this information from its vendors in many ways, including fax, phone, and email. The update process was essentially manual, and was unreliable both due to uncertainties in the vendors’ inventory records and poor timeliness of information updates. This led to frustration for customers, since they could place orders for products that were not in stock, leading to cancellation or long delivery times. The second problem with the drop-ship approach was that Zappos did not know when a customer order had been shipped. The vendor might promise to ship an order within a few days, but if it received a large order from a major department store, the Zappos customer’s order might be delayed. The customer was unhappy, and Zappos would not know that there was a problem until the customer called to inquire about the order.

Bringing Inventory In-House In response to these problems, in November 2000 Zappos began to stock its own inventory. One of the requirements of some of its vendors had been to have a physical store before they would sign up to be online suppliers (this was in the early days of Internet retailing, and manufacturers were unsure about the effectiveness of online selling). In order to meet this requirement, Zappos had purchased a shoe store in Willows, California that was going out of business but carried the appropriate brands. One of the attractions of Willows was that it was much less expensive than the San Francisco Bay Area, so when the company decided to carry its own inventory, it purchased an abandoned department store across the street from the shoe store, and turned it into a warehouse and distribution center. However, Willows, about 100 miles north of Sacramento, was not ideally located to be an Internet distribution center. There was no major airport nearby, and shipments were made by UPS Ground. The warehouse was a manual operation. While bringing some inventory in-house, Zappos continued to use the drop-ship approach with many of its vendors.

Experimenting with Third-Party Fulfillment Zappos quickly outgrew its Willows distribution center, which had only 30,000 square feet. UPS approached the company to manage its inventory and fulfillment. Under this program, Zappos

14 The company’s original website was shoesite.com, but this was later changed to Zappos.com.

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would continue to own the inventory, but it would be stored in a UPS facility near its hub in Louisville, Kentucky. Order fulfillment would be handled by a third party. The proposal offered several advantages, the most significant being that about two-thirds of customers could receive deliveries within two days using UPS Ground—and at a lower cost than shipping from Willows. Inventory and fulfillment would be managed using automated tools, which would be more efficient than the manual methods used at Willows, but without Zappos having to make a major capital investment. In 2001, after performing a detailed analysis, Zappos moved its inventory to the UPS facility. Within 6 to 8 weeks, however, it was clear that this approach would not work. The Zappos business involved more stock-keeping units (SKUs) than the system could handle, since each shoe style/size/color combination was a separate SKU. Thus, an individual style of shoe could require many SKUs. At the time, Zappos had about 70,000 to 80,000 SKUs.

Developing the Zappos Distribution Center in Kentucky Zappos decided that in order to provide exceptional service to its customers, it would need to develop its own distribution center, designed to meet the high-SKU needs of its business. They found an inexpensive building in Shepherdsville, Kentucky, less than 30 minutes from the UPS hub in Louisville. Due to a lack of capital, the company needed to build its warehouse as inexpensively as possible. As a result, they used static inventory shelving and hand-held bar code scanners, which stored information that was later uploaded to the inventory management servers—the cost of wireless communication between scanners and servers was beyond the company’s budget constraints. The Zappos team did not have previous experience in developing complex inventory management systems. Furthermore, they did not find other companies that had addressed problems similar to theirs, so they developed their systems in-house. As a result, the company developed its own systems and procedures focused on a highly SKU-intensive business that required virtually perfect inventory accuracy. To help bring up the new warehouse, Hsieh moved to Kentucky for five months, doing much of the software coding himself. From the company’s earliest days, Zappos had developed its own software, optimized to meet its needs, using open source programs in order to minimize costs. This practice was still in place in 2008. The company’s rapid growth required continual upgrading of both hardware and software in order to keep up with the escalating volume and to deliver a superior customer experience. At the end of each year’s holiday selling season, the IT group (always small, considering the company revenue, and numbering about 30 people in 2008) would make plans to provide double the capacity of the just-finished holiday season for the following year’s holiday season. They implemented these plans by mid-year, so that all systems could be thoroughly tested before the new capacity was required. In its new warehouse, stock locations were randomly assigned. A given stock bin might hold up to 20 pairs of shoes, but these would not be the same style, or even the same brand. The random stocking approach had a number of advantages—while keeping all shoes from a given brand together sounded like good organization, it created problems when they started shipping, and creating missing spaces in stock bins. Using random stocking, when a shipment arrived, it was separated into pairs of shoes, which were placed in the nearest available bins. The stock worker

For the exclusive use of F. Ortolano, 2016.

This document is authorized for use only by Flavio Ortolano in Supply Chain Management Summer 2016 taught by Ednilson Bernardes, West Virginia University from May 2016 to July 2016.

Zappos.com: Developing a Supply Chain to Deliver WOW!: GS-65

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scanned the shoe box and location when placing the box into a bin, telling the system the location of that particular item. When a stock picker went to get a box that had been ordered, it was easy to find the appropriate box in the bin, since it would be located with different styles of shoes from different manufacturers—the worker did not need to distinguish between the size 8 shoes stocked next to the size 8½ shoes of the same model sitting next to it. As its business grew, Zappos increased its warehousing capacity. The initial 265,000 square foot facility was filled to capacity by 2006, and the company opened a new 832,000 square foot facility, of which half was retained for future growth. Warehouse operations also became more sophisticated. The initial warehouse consisted of static shelving and simple conveyors. The new facility had some static shelving, but with automated conveyors. It also had automated carousels that spun until they reached the needed item, much like systems commonly used in dry cleaners—except that each of the 128 carousel loops in place by 2008 contained 32 units per floor and were stacked four stories high. In 2008, Zappos added more automation to its warehouse operations by installing a robotic system in which robots picked up shelves that contained the items to be picked (or empty places for items to be stocked), and brought the shelves to the workers. This greatly increased worker efficiency—in the first year it was more than twice as efficient as either the static or carousel methods. It was also more scalable, since new shelves and robots could be easily added when needed. (See Exhibit 2 for photographs of the Zappos distribution center.)

The End of Drop-Shipments Until 2003, Zappos was still sending orders to its vendors for drop-shipping, although the percentage of shipments from the company’s own inventory increased as it grew. The source of the delivery, whether from the Zappos warehouse or drop-shipped from the vendor, was transparent to the customer. However, evaluation of customer satisfaction showed that customers served by the Zappos warehouse were happier than those whose orders were drop- shipped. By March 2003, about 75 percent of orders were being shipped from the Zappos warehouse. The company decided that it could not provide customer service that lived up to its own standards by continuing the drop-ship business. The company leadership evaluated the situation, and decided that it should define itself not as a shoe company, but as a “service company that happens to sell shoes.” Hsieh explained, “We decided that we wanted to stand for something more than just making money selling shoes.” The service results at that time were not what Hsieh and the other leaders wanted them to be, but the revised focus helped concentrate attention on what the company needed to do in order to be recognized for superior service. Zappos immediately stopped using drop-shipments, cutting off 25 percent of its business in the short term. Zappos built this business back up as it increased its inventory to include those items that had previously been drop-shipped. The decision to bring all inventory in-house allowed Zappos to take those systems and procedures improvements required to increase inventory accuracy to nearly 100 percent. When the last item of a particular style/color/size was sold, that item no longer appeared on the website. Thus, any item that a customer selected online was in stock—the only exception being when there was just one left in inventory, and two customers had that item in their shopping carts at the

For the exclusive use of F. Ortolano, 2016.

This document is authorized for use only by Flavio Ortolano in Supply Chain Management Summer 2016 taught by Ednilson Bernardes, West Virginia University from May 2016 to July 2016.