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In South Lawndale sometimes referred to as “Little Village” on the West side of Chicago, stands a monument commissioned by the B. F. Ferguson Fund. This monument is intended to memorialize the site where two French explorers, Jesuit missionary Jacques Marquette (1645-1675) and trader Louis Jolliet (1645-c.1700), accompanied by an Algonquin Indian guide, realized that a canal could link the entire Great Lakes system with the Mississippi watershed. He reported in letters back to his sponsor that “it would only be necessary to cut a canal through half a league of prairie to go in a bark by easy navigation from Lake Erie to the Gulf of Mexico.”

The implication was clear, this investment would create a trading advantage and a supply chain across the continent and Chicago would be at its nexus. The implication was clear; trade advantage could be at stake.

Packyge is getting real

We (Chandra Shetty) are now a month or so into our modern day expedition with our startup called Packyge. We have locked down seed funding with some awesome investors who have jumped on board this journey and have been honored by an illustrious set of advisers who have considered us to be worthy of their advise. We are getting a lot of the inception “administrivia” behind us and are neck deep in product design and development. We are looking to add our very first employee(s) (we need mission driven folks physically able to be in the Western Suburbs of Chicago, not unlike Louis Jolliet! Click here to apply at [email protected]). We are also finding every opportunity to talk to retailers to guide our product development and to sign them up to help test our solution.

Its frenetic, demanding and intellectually exhausting! We love it, and just like back then; trade advantage could be at stake!

The course of a river is reversed

Starting in 1889 till early in the 20th century, work was done under the behest of a law created by the State of Illinois establishing the Sanitary District of Chicago to help safeguard the water supply of the City. This work reversed the flow of the Chicago river away from the lake and towards the Mississippi river basin. While the primary reason was public health, this channel also established water ways to extend trade from the North Atlantic in Canada to the Gulf of Mexico. It was one of the greatest feats of engineering ever undertaken till that time and it required thinking that was contrary to what had ever been done.. However, it came down to facing an existentialist threat to the city before such a drastic course action was considered, evaluated and undertaken. They reversed the course of a river!

Constraints and supply chains

We at Packyge believe that supply chains and the reliable, cost efficient and fast flow of goods have been core to trade starting with the early settlers/explorers and continuing into the industrial age. Even with the promulgation of Ecommerce and non store based trade; reliable, cost efficient and fast flow of goods continues to be critical for retail based enterprises. Modern digitally enabled direct to consumer models and expectations of ubiquitous availability of almost anything in (well) under two days to consumers tests the methods, processes and infrastructure underlying the reliability, cost efficiency and rapid flow of goods. A cursory analysis of the financials appears to show; at least to me, that those three tenets are at odds with each other. It is only under the expectation of scant to no profit can a business expect reliability and rapid delivery to be achieved. It appears that the good, cheap or fast (also known as the quality, speed, cost) triple constraint strikes again!!

A tale of two real estate sectors

As if to prove the point, the trend over the last 5 years is encapsulated in this statistic; “on a unit basis, approximately 2,880 store closings were announced YTD, more than twice as many closings as the 1,153 announced during the same period last year. Historically, roughly 60% of store closure announcements occur in the first five months of the year.” Further, Credit Suisse estimates that by extrapolating the year-to-date announcements, there could be more than 8,640 store closings this year, which will be higher than the historical 2008 peak of approximately 6,200 store closings. Reasons are becoming evident; retail rents, over inventory of locations and I won’t even reference the growth of Ecommerce since everybody knows about that.

However, even as the so called retail bubble was bursting; a severe shortage was brewing over in the warehouse space. Inventory was being absorbed at unprecedented rates and at increasing rents. Some of this is driven by very disciplined construction of inventory but a lot of it is driven by broad based demand. Looking at the Q1’2017 numbers for Prologis, the global leader in industrial space; Amazon is the largest tenant almost at 16 million square feet. Logistics companies join in the traditional retail tenants in the top 10. Ostensibly some of the capacity for those logistics providers is also being exercised by Amazon and other Ecommerce entities.
So whats happening? The edges of this network represented by the actual retail stores are shrivelling and the distribution points; starting one step inside the actual retail stores are growing. It’s not inconceivable to imagine that the emphasis in this network is shifting to optimize for reliability, cost efficiency and rapid flow of goods. I hypothesize that this new distribution network and the capability to distribute relevant stock constantly modulated to customer expectations across the network is the new trade advantage. Having to predict that in every store all the time is a different class of math problem.

As everyone knows this phenomenon is driven by Amazon and other members of its pure-play e-Commerce ilk. Going back to Louis Jolliet and the relevance of Chicago to transcontinental trade; according to Seeking Alpha, “Chicago boasted the most warehouse space under construction in a core market at the end of 2016, and experts said strong demand will absorb that product over the course of 2017. Vacancies are expected to stabilize near their year-end level of 8.5%”. Here is the kicker, Amazon is leading this growth in Chicago!

A mathematical problem

As the network shifts emphasis from the edge to other places it tests some fundamental mathematical assumptions underlying trade. In general, the systems, methods and processes are based on an understanding that the flow of goods has always been deterministic.

Consider this thesis; retailers defined fixed networks and forecasted arrival rates for demand into their stores and as long as they got it mostly right on average, something like 6 cents fell out for every dollar they were able to put into the top as revenue. Once they figured that out, all they had to do was stamp out stores across the country and magically 6 cents became $6 for every 100 store they were able to put down. Retail is a detail business and operators are formidable execution machines who will stretch a dollar like you wouldn’t believe and deserve the respect of everyone of us who haven’t done that job for a living. Retail is embracing Lean and Six Sigma now to drive further efficiencies and get better value for their investments.

However that efficiency effort and that culture is dependent on the foundation that there exists an established process which must be optimized based on the mathematical truism that average is a good measure for normally distributed data. If the process is flowing well with minimal utilization of resources (Lean) and the processes can be standardized such that most times the outcomes are within three standard deviations around the mean (Six Sigma), the outcomes will be acceptable 99.7% of the time.

However, what if the arrival rate is not normally distributed? What if demand cannot be accurately forecasted centrally because customers self select the items they want at prices that they can easily compare across all type of retail. What if the process cannot be normalized to have most occurrences happen beneficially 99.7% of the time? That desired outcome ostensibly is a customer predictably buying a basket or item at predictable net profit in a repeatable fashion. That’s why the store was stamped out in the first place, right?!

Customer demand cannot be modelled reliably because the variables influencing it are varied and multifaceted. Digital information sources, social media platforms, pureplay online retailers, fast growing new brands born digitally and other recent phenomena born of digital penetration into consumer lifestyle create a heady cocktail where simple average/mean based math reliant on a fixed origin (warehouses) and destination (stores) points starts falling apart.

So what is a retailer to do? If it’s becoming harder to be profitable by predicting what inventory to place across a retail chain; shouldn’t retail operators reconsider the foundational assumptions underlying network and systems, methods and processes based on pushing inventory out into the network? Maybe the approach to consider is to reverse the emphasis in the network and think about systems methods, processes that are based on responding to pull from the edges of the network represented by the consumer and remove the burden of being right most of the time in every store for every customer in the face of rapid changes in expectations. Getting that right will require wholesale transformation of the infrastructure behind retail and will take time and most likely a healthy dose of AI. In the meantime, that privileged asset of the location needs to be exhaustively leveraged. For every second that it drops cost on the income statement it should be a location to attract revenue, by any means possible; preferably aligned with the emerging digital consumer lifestyle.

If the cost to make the beneficial outcome of making a profitable transaction with the consumer is to be optimized for profitability; then the cost of stores, cost of supply chain, working capital tied up in inventory should either be stripped bare or more GMV transacted per unit of spend or both. What if there is a metaphorical portage that connects online trade with profitability within retail locations even as we accept that retail locations will atrophy to correct the excesses of the past?

What is not tenable is the relentless approach being practised right now by traditional retail. This is clearly evidenced by the growth and deterioration of the various parts of the supply network and the noticeable involvement of winners and losers in the respective parts of the network. The implication is clear; trade advantage could be at stake.

Conclusion

Louis Joliet made an observation regarding connecting two distinct trade systems by making an investment in a previously unrealized connection in the network. On the brink of existentialist threat a city pursued a previously unthinkable endeavor of reversing the course of a river. We at Packyge think that modern retail in this inflection will have to reconsider its foundational assumptions and come to the conclusion that retail is a fundamentally different math problem. What they must now do is rethink the emphasis in the network and redirect their focus, approach and investments in the flow of their network and they will have to do the currently unthinkable; not unlike reversing the flow of the Chicago river.

We at Packyge are focussed on the opportunity this change presents. We are building solutions to help retail locations fight out of their stores.

#fightoutofyourstores