McKinsey: How are the logistics functions organized at Sears?

Gus Pagonis: I am a strong believer in centralized control, decentralized execution. In the Gulf War, General Schwarzkopf made the US Army's 22nd Support Command responsible for logistics. He agreed that there had to be a single of point of contact (SPOC) for all issues related to logistics. At Sears, Arthur Martinez, Chairman and CEO, had a similar vision. He agreed that our logistics organization, the Sears Logistics Group, be the SPOC for all Sears logistics. Previously, each one of our businesses had portions of our present logistics organization. So these logistics operations were buried within various structures throughout Sears. It used to be extremely difficult to put your finger on a logistics problem, because no one executive had total responsibility. I believe Sam Walton was the first retailer to have the vision of centralizing the logistics function in one organization and bringing in a logistician into his top management group.

What role do you play as a logistician on the executive committee of Sears?

Martinez, like Schwarzkopf, wanted logistics to have a voice on the executive committee equal to that of the various Sears businesses. This also would ensure that all new ideas could be reviewed for their logistical impact. If for example, someone wanted to find out whether we could logistically support a concept, we would test it. We may find it was too costly in some markets, and unnecessary in others, all of this being done, of course, prior to making a national decision.

The same goes for some of our seasonal items. Air shipping snow blowers or lawn mowers from one of our stores in one region to a store in another region to meet growing demand might seem to make a lot of retail sense, but when you examine the logistics cost and the gross margin it does not make economic sense. Having the Executive Vice President of Logistics with an equal vote on the CEO's Executive Committee allows all costs to be considered in the decision.

We can also act on the logistics-related issues much sooner. Take promotional items. We know six months in advance what items are going to be promoted, so we can take appropriate logistics-related actions. Unlike in the military, where the enemy situation can suddenly change, here we have the opportunity to make more deliberate plans. For example, we need to be prepared for Christmas every December. The only downside is that while I used to enjoy Christmas in the past, I now begin worrying about it in May.

How does the CEO know whether the logistics team is meeting its objectives?

Just like we did with General Schwarzkopf in the Gulf War, every month we present Martinez and the other members of the executive committee with a single sheet of paper that contains all data on logistics performance—good and bad. This Logistics Situation Report (LOGSITREP), prepared by my finance department, has all the service and cost metrics for our various channels, including direct delivery (home deliveries), take with (merchandise customers can carry from our stores), and fashion—broken down to the level of per carton, per order, and per piece. All of these numbers are tied in with the company's financial numbers so the committee has a clear idea as to how much we are incurring in transportation, distribution, and delivery costs and how well we are managing our inventory, our vendors (in so far as recovering the costs of defective products), and even our home office expenses. This single piece of paper is probably the most universally used document within both our logistics organization and the businesses we support.

How much of the old logistics organization have you retained?

I have always tried to work with any existing organization I inherit since I don't want to lose the things that are working. Military training is good in that regard. In the Army the people you work with change about every six months. So you spend a lot of time training replacements. Here, having people stay in the same job for longer periods of time is an advantage. The leader's role is one of reinforcing the standards and training. I decided from very early on that I was not going to restructure or reorganize the logistics organization: I was going to tweak it. The talent was all there, but it was all over the place. When you consider that in the military I generally had about 50,000 people working with me, and here I have 9,000, it is a lot easier to reach out to more of the organization on a personal basis.

What role does the log cell play in this organization?

It is similar to a log cell in the Army. It performs three tasks: formulates logistics strategy; provides training and implementation support through the log cell project managers; and provides help on pressing logistics issues or crises through the "ghostbusters," who are highly trained surrogates, able to go anywhere within Sears to resolve issues. We decided that the four ghostbusters, in addition to covering a territory within the US, should also focus on one of our four channels. Every two years or so we will switch their assignments, to help provide them with a greater range of experiences so they can improve their ability to solve problems or better yet, anticipate and fix problems before they occur. One of the good things about the ghostbusters is that everyone knows who they are, and that they not only correctly identify the problem, they stay with it until it is fixed systematically, so it doesn't occur again.

What were your priorities after you arrived at Sears in 1993?

Military logisticians know very well that it is the soldiers who are their customers. Take care of their needs, and the broader military objectives—no matter what they are—will be accomplished. Business logisticians are not used to thinking that way. As soon as I arrived at Sears, I asked our logisticians, "Who is our customer?" It took us a day to figure out that we have three. The first was well known to everyone within Sears. It is the target customer who shops in our stores. Our research had shown that this customer was generally a woman, between 25 and 55 years of age, who was responsible for buying not only all women's and children's apparel for the home, but also a lot of the men's apparel, home furnishings and appliances, and even tools. For this ultimate customer, we want to make sure that the product she desires is in our stores when she wants to buy it.

While everyone is focused on this segment, we, the logisticians, have a second and especially a third type of customer that are unique to us. The second consists of the various vertical businesses within Sears around which we merchandise and market: Brand Central, Sears Auto Centers, and HomeLife furniture stores, for example. We want these businesses to have confidence in our ability to flow goods in a fashion that will persuade them to cut down in-store inventories, by emphasizing quick turnaround. The third customer is our stores. Unlike Wal-Mart, which has 2,600 stores mainly built as a single block, most of our 800-plus stores are mall-based. Thus we are bounded by the design of the mall—at least in terms of where we can dock and unload our trucks, and so on. So while it may be very cost-effective to increase space utilization of our trucks and reduce shipment of empty space, we had to ascertain if individual stores had the capability, within their unique configuration, to unload them. If not, our cost savings could quickly disappear. We needed to target these stores as customers and customize our shipments to their unique requirements. In addition to objective measurement criteria such as arriving at a dock within a delivery window 98 percent of the time, or ensuring 99.5 percent accuracy in the items delivered, we now use subjective criteria such as, "How well was the truck loaded?" We want our logisticians to say, "We are responsible for the load and its ease of off-load by the stores."

How did this emphasis on improved customer service relate to your bottom line?

Another area we focused on was identifying every logistics-related cost and charging the proper person or group. If people do not know the true cost, they will make decisions that they would have never made had they known. Take our experience with cardio fitness machines. We were supposed to sell 40,000 of these units in a season. We sold 60,000 in the first week we introduced them into our stores and sold 170,000 for the season. The stores were in constant need of replenishment. If we had moved this merchandise using premium transportation, the costs could have wiped out our entire gross margin. From a buyer's perspective, huge sales of this sort are terrific. But now we can relate the logistics costs associated with such unexpected sales increases. Not surprisingly, they now care about these costs.

Similarly, we now know that it costs us more to move a carton of tools to a stand- alone hardware store than it does to a mall store. Our hardware stores aren't happy about finding this out, but at least the true costs are now visible for decision making. Today, we can identify every logistics-related cost. We have unbundled these costs from cost of goods sold, where they would have been hidden in the past. Many logisticians will tell you that it isn't worth doing. We would agree that in about 10 percent of the cases they are right. In the majority of cases it is worth finding out. Our costs are the expense items of the various businesses, and they need to better understand what their costs are. Averaging logistics cost is definitely not a good practice—actual costs must be determined for the best decision making. With branded or commodity-type products pricing is very competitive. Therefore, the company with the lowest logistics cost per piece and best customer service will have an advantage.

But surely the costs depend on a variety of factors?

That is why we focus on total cost, which includes the entire cost of getting product from a vendor to the ultimate customer or liquidating returned merchandise. This cost tends to be primarily transportation expense, which moves a product from a vendor into our pipeline, distribution expense, which we classify as the cost of running our distribution centers, and home delivery expense, which is the cost of delivering merchandise to our customers' homes. These three cost components together total more than $1 billion. So it is huge. Viewing the entire total logistics chain pipeline in this way also helps us make better strategic decisions about moving a product faster through the pipeline: for example, there are benefits of being first to the market with a fashion item. But we need to look at the total chain. This is why we have a problem with the term "supply chain." It connotes warehousing and maybe transportation, but that's it. Information Systems is critical to making a pipeline function. "Logistics chain" is a better, more encompassing term.

Is it possible to have too many numbers?

It is an easy trap to fall into. Organizations produce so much statistical information that, unless you seek out what you really need, you can get lost. Few organizations kill reports even though they might have exceeded their useful lives. Many organizations also have a similar approach to surveys. Got a problem? Let's do a survey. There's too many surveys. Any survey that an organization does should be linked to quantifiable objectives, otherwise it should not be done. And when surveys are conducted they should be very targeted. If we want to know whether something was delivered to a customer the day it was promised, we need to know "yes" or "no"—not "maybe." The answer should be obtained as "red" or "green" not "yellow." Most accidents at traffic signals happen on a yellow. It is also easy to focus on the numbers and lose sight of the strategic intent. If you only want to reduce transportation costs, hand over logistics to a transporter; he'll ship everything by barge.

What do you do with cost data once you have identified them?

They become part of our closely followed numbers. Just like in the Gulf War, where every logistician had very definite, quantifiable objectives to meet such as, "set up logistics base Charlie by February 15, 1991," for example, we want every logistician within Sears not only to focus on bringing our costs down, but also to consider service requirements. We don't say "reduce costs." We say "we will reduce costs by four cents on every carton that goes into a regional replenishment center by June 30, 1996 and ensure service scores stay at 98 percent or above." We provide clear, concise, quantifiable objectives. We do not work on anything that is not related to these quantifiable objectives. Not surprisingly, over the last three years we have managed to meet very aggressive targets for reducing costs as a percentage of sales. Obviously most of our cost is variable, so as our business grows and we have more volume, real dollars of expense grow with it. For instance in our outlet stores (positioned in the logistics chain as part of the product flow for liquidation) cost recovery is part of our report card for success or failure. We have some control over the variable costs, but they are dependent on sales. What we can control are the fixed costs. We want to take out as much as possible of our fixed costs so we can recover more of our gross margin into our net margin. People have said this will be tough to achieve, but we are well on our way. These days, for example, we try to lease—not build—warehouses. Some of our warehousing is third-party operated. All of our transportation needs are met through third-party providers. We do not own any trucks.

How do you ensure third-party providers maintain proper service levels?

Transportation is no less complex than the Army's. We make about 4 million home deliveries a year. We moved 600,000 truckloads of goods last year through our network: all third party. We want our providers to view our customers as their customers. As third-party contracts come up for renewal, we are inserting language into new contracts that requires providers to pass on incentives that we provide them to their frontline troops. We want to make sure that a transportation company, for example, is passing on some of these incentives to its home delivery drivers who treat our customers well. We realize that it is an art to instill this level of subtlety into contracts. Over time we will figure out how to write these contracts better and encourage our providers to work with us as real partners rather than with an "us versus them" mentality.

In the Gulf War, you were responsible for all vendor relations. How is that managed at Sears?

We have 3,700 vendors, 1,000 of whom change every year. A large portion of the money we make comes from products we purchase from 20 percent of our vendors. Obviously, our buyers need to manage the primary relationship with each vendor, but where the logistics organization can help is to educate and support the buying organizations in their day-to-day dealings with vendors. We may not know a lot about fashion or styles, but once they are selected, the responsibility for getting the item to our customers is all ours. We have therefore developed some principles for managing the vendor community, which are tied to the way we communicate requirements, the way we monitor compliance with our requirements, and the way we assess penalties for noncompliance. One of the biggest changes Sears made has been in the area of vendor compliance. Sears was once known as the "paper tiger" of the industry—all bark and no bite. Now, vendors know that Sears will be fair, but also very firm.

We have set up a vendor advisory council comprising some of our key vendors, whose input we seek on the way we work with them versus the way other retailers work with them. Sears has truly solidified relationships with its vendor community. With their help, we have automated a great deal of the store receiving process. Now all that stores need to do is scan an electronic manifest, unload the truck, and put away the goods. This eliminates manual receiving.

You have introduced several aspects of your management style that you had developed in the military. How have people reacted?

I think people are comfortable with them. In my first two weeks here, I was not getting any negative information. I kept asking, "Aren't there any problems?" The answer would invariably be, "No, everything is fine." Then I said, "OK, each of you will give me three ups and three downs." We now require that people who come to our meetings tell us three ups and three downs about what they wish to report; they also need to share how they plan to fix the downs. Initially people had a problem with the downs. They would put up a chart listing their ups, but no downs. But when we told them that they either start providing downs themselves or we would start filling them in for them, we began to see downs listed.

We also use the "three ups and three downs" approach in our personal evaluation system, and suggest to our associates what they can do to fix their downs. It's of limited use to tell someone that they have a problem with their writing, unless we can also tell them "Penn State is offering a course in writing and I am signing you up to take it." We are trying to create a "negative-free" environment. Only then will we get people to open up to others and their managers about problems they face in their work. We like to say: "Bad news doesn't get better with age."

As I said earlier, we have also introduced situation reports, or what we called "sitreps" in the military. Here, instead of informing one another about ammunition levels, we inform one another about inventory levels. Then every day of the week, except Mondays, we have a short "standup" meeting, which anyone in the logistics group can attend. On Mondays we have a mandatory "sit down" staff call where only the senior members of the group—or their representatives if for some unusual reason they can't make it—attend. Many decisions are made at this meeting. A substituting deputy can make a decision at the meeting on behalf of his boss, who then has 48 hours to overturn it or forever live with it. Like the Army, we also have "three-by-five" cards, which people can use to inform us of relevant facts we might need or for an update on a situation. We have introduced an electronic three-by-five format that associates can e-mail but they must not exceed the number of lines marked on the format. Our aim is to instill total openness in communications up and down the chain of command. Our local delivery units now have standups every morning before they start their home deliveries which works great.

How do you foster an environment of openness?

People who do not know the logistics group are often surprised that we have such a level of disagreements at our meetings. I do not blame them. How many organizations can you go into, where in a meeting, vice presidents argue with each other in front of their boss and with their boss? And what is nice about it is that when they leave the meeting, they do not feel frustrated or that they have missed an opportunity to present their case. There are no side meetings that take place either before or after our meetings where people say "I did not get a chance to cover this" or "I wonder what he meant by that." I also regularly visit with all departments. That way I know what's on their mind, what they are working on, and what problems they anticipate. I want to avoid surprises. I also have "please see me" times. Anyone can sign up on my "please see me" time roster. That way they don't have to be kept waiting outside my office.

What have you found to be the most striking differences between the military and business?

Arthur Martinez likes everyone to use first names, which I totally support. So nobody calls me General anymore! I go by Gus. This proves the point that you don't need a title or an authoritative position to get things done. There is a big hang-up in the military world with positions. When I was in the military, I would be in the minority because I would say "You do not have to have rank. There is nothing wrong with a captain telling a major what should be done." This notion of a non-hierarchical workplace is much more readily accepted in business, even though there are secret pecking orders. But in our group we have eliminated that. I do not think there is anybody within the Sears Logistics Group who would not challenge me or any of our vice presidents or each other!

Does problem anticipation come more easily in the military than in business?

The ability to anticipate problems is probably the single biggest distinction between the military and civilian sectors. In the latter, there are some great people who can anticipate, and they very quickly become known for their ability to do so. In the military, even the below-average person can anticipate because lives depend on it. All military training is about anticipating problems and developing alternative plans to prepare for them.

Do you ever worry about failure?

No! If I fail, the worst that can happen to me here is that they'll fire me. But it's only me that's going to be affected. In the military, if I did something wrong an entire division could run out of fuel. A bad decision could sometimes be impossible to correct. The pace in the civilian environment is a little slower—which allows more recovery time. But no one should worry about failure, whether it is in the military or civilian world. Just take care of and train your people, and the mission will get accomplished.