The retail supply chain of yesterday can no longer serve the customer of today on its own. Big, centrally located distribution centers (DCs) were built to ship products at set intervals to stores, and stores were where customers shopped. But today we are in an environment with a higher prevalence of e-commerce shopping (30 percent higher penetration than pre-COVID-19), higher customer expectations when it comes to delivery speed, and higher availability of excess space within stores—which combined create an opportunity to evaluate new fulfillment models that move beyond the DC-centric model of the past. Today’s customer requires greater agility and greater speed than ever before, beyond what central DCs are currently set up to deliver on their own (Exhibit 1).
In response to these trends, retailers are thinking outside the (big) box to reimagine their “slow-twitch” supply chains, building for “fast-twitch” models that can serve customers directly and rapidly. This has led to the emergence of three horizons of change in retail-fulfillment operations: within the store, around the store, and in the neighborhood (Exhibit 2).
Within the store: Moving away from the traditional distribution center
Retailers are using their existing assets to build operations that better serve the omnichannel customer. Major players such as Target, Walmart, and Best Buy are using their less productive and excess store space as a competitive advantage to fulfill e-commerce orders from stores. Using stores as fulfillment centers allows retailers to ship from locations closer to customers, which in turn drives down delivery times and cost.
To unleash the power of “within the store,” retailers must set their “North Star” aspiration for customer promise and determine how much capacity is needed to realize it. For example, do they want to promise two-day shipping to all customers based on minimum spend like Walmart, or same-day shipping for many products at minimal additional charge as Best Buy does? Based on this aspiration, retailers must define how much capacity is needed across stores for order fulfillment and which stores are in the right geographical location to handle the demand.
Once this foundation has been laid, retailers can begin to design their building blocks: the right physical model, the right inventory, and the right operations.
The right physical model
There is a wide spectrum of operating models that retailers can choose from to build fulfillment capability in store. Options include the small and manual, where retailers repurpose back-of-house or dedicated office space to transform it into a packing and shipping room with lean operations. This model often prevails for retailers with high productivity per square foot (luxury retailers, for example) that don’t want to sacrifice selling space but do want to deliver on a more rapid delivery promise than a centralized DC would allow. At the other end of the spectrum are retailers that are building mini-DCs within their stores by walling off and remodeling large portions of the store, installing shelving for inventory, and building automation for picking and packing. This model often prevails for retailers with high e-commerce volume and unproductive selling space that is ready to be repurposed.
Kiehl’s is on the front end of this spectrum: store associates pick goods from the sales floor to fulfill online orders. Orders are then packaged in a back room or stock room for delivery to customers via mail. Given the small footprint of the stores, packages are often kept in the store front while awaiting pickup by delivery providers. This model does not incorporate automation, as all duties are performed by Kiehl’s associates, and it only requires dedicated store space for packing.
Toward the middle of the spectrum is a model that combines the power of the sales floor for picking most goods with a back room housing the fastest-moving SKUs that are high-velocity items for e-commerce orders. By having associates pick high-velocity items from a back room, this model saves time in two ways: associates don’t have to walk the sales floor to find products, and products never have to be merchandised or prepared for the sales floor after they are received. Target, for example, has built custom in-store fulfillment operations and expanded them broadly—approximately 95 percent of Target’s digital orders today are fulfilled from within its stores.1
At the furthest end of the spectrum are robots. Companies such as Takeoff Technologies provide in-store automated solutions that support picking and thus provide enough efficiency and output to allow retailers to set up mini-DCs in their stores. Takeoff’s automation solution takes up about one-eighth of a store and cuts order fulfillment time by more than half. Currently, Takeoff’s automated solutions are most often found within the grocery space, including Loblaws and Ahold Delhaize.
Regardless of operating model, the resulting impact on retailers’ in-store fulfillment costs (mainly labor and shipping) is meaningful, bringing costs within about 20 percent of traditional DC costs for the simpler models and close to parity (with traditional DCs) for models that incorporate automation.
The right inventory
Depending on how ambitious the retailer is, forward-deployed inventory can and should solve for several factors in product assortment—namely, the breadth, depth, velocity, and “combinability” of that assortment. Each factor’s influence on in-store fulfillment greatly depends on the selected operating model. For example, the breadth of assortment in a store that depends on goods picked directly from the sales floor only needs to mirror existing assortment, accounting for additional volume. In automated, mini-DC models, the assortment should reflect the regional omnichannel demand and will require defining a new assortment profile that takes into account products that are frequently purchased together in order to reduce split shipments.
To successfully forward deploy any assortment, retailers must be able to do three things well:
- Forecast: analyze market data to improve forecasts for SKUs with strong omnichannel demand.
- Manage life cycle: determine the optimal cadence for replenishing products to mitigate the need to redirect inventory at the end of a life cycle (for example, from stores back to DCs or from full price to markdown).
- Practice order fulfillment logic: build rules to route customer orders to optimal store nodes.
The right operations
Bringing modernized fulfillment operations to life—whether big or small—requires the willingness to invest in new equipment or technology, to redesign physical spaces, to overhaul operating procedures, and to create new in-store roles. Retailers can begin by putting the right labor and labor model in place. Smaller operations will often share labor with the existing store teams and add more employees in high seasons from seasonal, temp, or gig-worker pools. Employees can be cross-trained to pick and pack inventory and to assist customers. This approach requires retailers to emphasize, and even rebuild, training programs to ensure associates are prepared for multifaceted roles.
Larger mini-DC spaces require dedicated labor hired specifically for in-store fulfillment. While training is of course still necessary for these roles, recruiting efforts must target candidates with specific fulfillment-focused profiles or automation experience.
Similarly, the store’s operating hours may need adjusting based on the new fulfillment model being built. Fulfillment from the sales floor occurs during business hours and has the added benefit of having more associates present to interact with customers during busy periods. An expanded mini-DC operation may require extended operating hours (for example, 16 to 24 hours) depending on the volume of orders being filled.
For more detail on the physical model, inventory, operations, and beyond, when it comes to leveraging stores as a distribution node, see the December 2021 McKinsey article, “Reimagining the role of physical stores in an omnichannel distribution network.”
Around the store: Looking beyond the store’s four walls
For retailers that don’t find themselves with adequate excess space to set up an in-store fulfillment operation (or for those with concerns about in-store experience), there is the option to move both beyond the DC and beyond their own store’s four walls. Two-way fulfillment or distribution as a service is an emerging model that pools demand across retailers to create density (that is, enough e-commerce orders or returns to warrant stepped-up operations) and to drive lower costs through scale.
A prime example of pooling the power of customer demand to drive up efficiency, drive down costs, and get closer to customers is happening in the retail real-estate space. Many mall operators are recognizing the role their centers can play in servicing omnichannel demand while improving store health, and have launched efforts ranging from space offerings all the way to providing full-service, shared fulfillment operations (for example, Brookfield Properties Concierge Services). Brookfield’s 2022 launch of fulfillment services with Sephora marks a unique entry for US mall operators, with the mall and its logistics and technology partners directly housing and handling curbside orders for the beauty brand, over time aggregating similar fast-twitch “omnidemand” across retailers that is more efficient and speedy for the mall to handle in market.
A second example of the move to “around the store” comes in the form of partnerships between big-box retailers. In 2021, Home Depot became Walmart’s first customer for its GoLocal service, which offers delivery-as-a-service fulfillment. By relying on Walmart’s expansive network of last-mile delivery drivers, Home Depot can continue to expand its ship-from-store capability and push to reach its goal of next-day delivery to 90 percent of the US population.2
On the opposite side of fulfillment as a service, bringing goods from retailers to the customer, there are emerging players that capitalize upon customer’s desire to return e-commerce purchases to retailers and consolidate and simplify that practice for retailers. Happy Returns, as one example, has over 3,800 “return bars” across the country, providing retail partners more touchpoints for customers to easily return unwanted items. Happy Returns centralizes returns for retailers like Rothy’s, Levi Strauss & Co., and Revolve and allows customers to bring items purchased from partner retailers to be seamlessly returned without packaging or labels.
In the neighborhood: Q-commerce brings ‘instant’ order fulfillment to the table
Even as they adopt new models to fulfill orders faster, retailers may soon find that two-day delivery isn’t fast enough. Twenty-minute delivery windows are threatening to be the new two-day delivery, and start-ups in quick commerce (Q-commerce) around the globe are blazing the trail, specifically within the grocery and convenience spaces.
Q-commerce players are shaking up speed paradigms by offering “instant” delivery within as little as 20 minutes. These players focus on a small market radius by locating dark stores or satellite stores near concentrated areas of demand. The new model is gaining ground in the grocery market, with potential to expand to other retail segments soon.
As investment and new competitors enter the market, two major players are garnering significant attention: Gopuff and Gorillas. Gopuff launched in 2013 in the United States and now has more than 450 locations domestically. Gorillas launched in May 2020 in Berlin, raised more than $300 million in less than 12 months (and has most recently raised close to $1 billion through a round of series C funding3) and today employs about 10,000 people (up from 20 employees in its infancy, just two years ago).4
While still a new and largely untested market, Q-commerce is on a growth trajectory, and with that growth comes an extreme shift in the traditional distribution center paradigm. While the DC-based fulfillment model focuses on locating a few behemoth centers strategically across a country, Q-commerce players concentrate multiple warehouses in a single city to best serve customers in the condensed time frame they promise. Gopuff, for example, has about 40 warehouses in Chicago alone. Continued investment in this emerging industry coupled with consumers’ ever-intensifying delivery demand signals retailers to start thinking today about how to compete.
Next steps: Take immediate action to move beyond DCs
With competition gaining speed, the time is now for retailers to build a competitive customer promise and delivery capability, or else face falling behind. Retailers can take three immediate next steps to move beyond the distribution center:
- Get moving, because time is not your friend. The COVID-19 pandemic accelerated e-commerce growth by five years. Competitors are prioritizing investment in their fulfillment capabilities, and they will steal market share from retailers that don’t deliver on a compelling customer promise.
- Don’t skimp and settle for a simple, lower-capacity model because it is easier. Build capacity for the future, even if that means automating or branching out with partners in the near term, because perfecting your model will take time. Once your “North Star” aspiration is set and capacity needs are defined, go for it.
- Break down the silos between functions to unlock the power of the store. Moving beyond the DC is not a project for supply chain alone, nor is it a project for stores alone. Retailers will need to partner with internal teams across the business—from merchandising to plan assortment, supply chain to get the right inventory on the shelves, HR to push the labor model to the next level, and of course stores to create the heart of the solution. Further, ensure partnerships extend beyond the organization when needed to include automation providers, mall operators that are aggregating density, and other third-party providers.
With so many innovations on the horizon, and consumer demand intensifying for faster delivery speed at low cost, retailers must act now to identify and deploy the right fulfillment model for their business and their customers. The world is changing, and slow movers will be left behind.
