Smart tags, high costs

RFID technology is hot, but the costs and complexity mean that ROI for suppliers is a long way off.

A little over a year ago, when Henkel Consumer Adhesives Inc. needed to replace its warehouse management system, the company chose a forward-thinking vendor that was planning to use radio frequency identification, or RFID, which was then, as now, being touted as the "next great thing" in supply chain automation.

Little did executives at Avon, Ohio-based Henkel know that just a year later, thanks to a mandate that Wal-Mart Stores Inc. issued to its top 100 suppliers, they would be planning a pilot based on this costly and still problematic technology, with the intention of going live by January 2005.

RFID is forecast to be a $3 billion market within five years as this sophisticated tracking technology gradually begins replacing its cheaper but less powerful predecessor, the bar code. Compared with bar codes, RFID tags store more information about the products or containers they're placed on. And they don't require manual scanning—RFID readers capture data automatically when tagged items or containers are within a certain range.

On a receiving dock an entire pallet could be read all at once, increasing productivity, reducing labor costs and eliminating human error. Or an RFID tag could tell workers where to place containers coming into a warehouse.

When the data is shared among retailers and manufacturers, it enables real-time tracking of goods, resulting in unprecedented visibility into the supply chain, thus reducing shrinkage, idle inventory and out-of-stock items. Fast-selling items can be replenished more quickly, increasing revenue for both suppliers and retailers.

Large retailers such as Benetton and Marks & Spencer claim returns on their RFID investments, and Wal-Mart predicts 10% to 20% improvements in labor efficiencies in its distribution centers.

However, the vast majority of suppliers will take at least two years to see any return from their RFID implementations, observers say. In fact, if the Wal-Mart mandate hadn't occurred, analysts say RFID would likely have followed an adoption and maturation cycle similar to that of bar codes, which took at least a decade to achieve widespread adoption.

AMR Research Inc. in Boston estimates that suppliers will spend $10 million to $20 million each to meet Wal-Mart's mandate, including hardware, engineering services and integration with existing software. ARC Advisory Group Inc. in Dedham, Mass., puts the cost at $250 million. Either way, "it's clear that the payback will be far longer than two years," says Steve Banker, service director of supply chain management at ARC.

Indeed, although Henkel anticipates great benefits—including reduced inventory, better manufacturing planning, reduced cycle time and, ultimately, higher sales, "we might have moved at a different pace" if it weren't for Wal-Mart, acknowledges Gene E. Obrock, vice president of operations at Henkel, best known for its Duck brand of duct tape. An ROI model, Obrock says, isn't even relevant at this point. "The technology is so new that even if we set up an ROI analysis today, in a year we'd be developing a whole new ROI model and still revisiting it frequently," he says.

"If you're being forced to do it, then you have to do it," concurs Barry Mason, an analyst at Nucleus Research Inc. "Others—while they should take this technology seriously—need to take a wait-and-see approach."

Overcoming Complexity

One way to lower costs is to delay bulk tag purchasing until prices drop, which many, including Obrock, see as inevitable, particularly with the billions of tags Wal-Mart's suppliers will demand. With tags costing 30 cents on average, only certain products—watches, DVDs and CDs, for instance—would be worth tagging.

According to Gartner Inc., the cost of tags will have to fall to 10 cents each before the price is right for pallet- and container-level tagging, and it will have to hit 5 cents for item-level tagging to be affordable. Some observers predict 5-cent tags by 2006, but others say that's optimistic.

But tag costs are only the beginning. Consider if a supplier simply complied with Wal-Mart's mandate—what some call the "slap and ship" model. In this approach, suppliers would tag containers right before they leave the warehouse, not when they come off the manufacturing line. This means that when a truck arrives at the warehouse, the containers destined for Wal-Mart need to be segregated, sent to special tag-printing stations and placed on separate pallets. "You're rearranging the warehouse to accommodate this—how much will that cost?" Banker says.

Furthermore, older warehouse management systems will have to be customized, which can cost $50,000 or more. Special middleware will need to be added to accept, sort and translate the new RFID data for the warehouse management system and to process advance shipping notices in a new format. "Believe it or not, this is the cheap path," Banker says.

The other approach is to push RFID further back into the manufacturing process, tagging containers before they reach the warehouse or even requesting your own suppliers to adopt RFID. This way, suppliers can reduce labor costs at the receiving dock and speed shipping processes. But it's questionable whether this offers a compelling ROI for many suppliers, which—unlike retailers—may already operate at high levels of inventory accuracy. "If they're at 99% efficiency now, and RFID brings them to 99.5%, that in no way offsets costs," says John Fontanella, vice president at AMR.

Wal-Mart itself is encouraging suppliers to do more than slap and ship. "You have to capture the information and put it back into the system to make better decisions," Obrock says. "If you do it any other way, you're short-cutting your ability to generate savings."

Of course, this adds more integration costs and requires a re-engineering of business processes—still with no short-term ROI. For Henkel, figuring out how to do that will likely take the better part of six months. "We'll be looking at where the technology fits, what applications we want to take advantage of, what procedural changes we'll need to make and what those changes mean in terms of cost savings," Obrock says.

Where RFID Works Best

Still Fontanella and others say there's a way to both comply with Wal-Mart and achieve shorter-term payback. It involves looking within your company and defining a discrete process that could benefit from RFID automation.

Fontanella suggests considering an area where process discipline is very important yet difficult to achieve manually. For example, International Paper Co., had problems reading bar codes on its massive rolls of paper when the rolls were stacked deeply. In addition, when rolls were cut to fill an order, the bar code was sometimes cut with them, leaving partial rolls with no indication of their grade or the amount left. Stamford, Conn.-based International Paper inserted RFID tags deep within the rolls, thus increasing inventory accuracy, eliminating waste, reducing operating costs and decreasing inventory levels.

Sometimes the environment itself calls for RFID. International Paper's warehouse, for instance, is very dusty, making bar-code reading difficult.

There are other rules of thumb to consider when looking for processes that would benefit from RFID. For one thing, experts advise looking for activities that involve a lot of manual labor—if you have 500 employees using bar code readers to scan tens of thousands of packages each day, for example.

Another possibility is order-picking. "If a shipper needs to pick three of one product, eight of another and 10 of another and put it on a pallet, with a reader mounted right on the equipment as the person is filling the order, it can ensure the person isn't counting wrong," Mason says.

Large or high-value goods are also good candidates for RFID tracking because they yield better ROI than low-value goods, since the per-tag cost is less of an issue. Plus, Banker points out that better asset management helps reduce theft.

And one way to track high-value goods is by their containers. TrenStar, a mobile asset management firm that uses RFID to help companies such as beer distributors in the U.K. track their containers as they move through the supply chain, chooses to use RFID when the container itself is valuable. "It's more worthwhile to track a container that costs $1,200 than a cardboard box," says David Adams, senior vice president of corporate strategy at the Englewood, Colo.-based company. TrenStar claims to have decreased cycle time for beer distributors and cut keg loss by two-thirds.

And low-cost goods can have high value when they hold a key place in a manufacturing process, Adams points out. For instance, a container of 39-cent spark plugs might cost $4, but if the part doesn't arrive at the right point in the manufacturing process, "it could shut down the whole plant," he says. TrenStar has been conducting a pilot at Kraft Foods Inc. in which it manages the process of sending stainless steel containers to Kraft suppliers to fill with processed fruit for yogurt. Because the containers are tagged, Kraft can look on a TrenStar Web to learn where the containers are and when they will arrive at its plant. With this information, Kraft can plan production runs more accurately.

Some of these applications may call for more expensive and more mature RFID technology, such as active tags or those with proprietary standards—not the passive tags Wal-Mart is mandating.

Unexpected Benefits

Despite the long-term ROI, as suppliers experiment with RFID, Fontanella believes innovative uses of the technology will emerge. Indeed ROI can come from unexpected places. Adams points out that because his beer-brewing clients were able to produce audit trails of where their kegs had been, they were able to receive a tax credit for the ullage, or waste beer at the bottom of the empty keg.

And in the end, companies like Henkel say they are glad to be investing in innovative technology now. "Why not challenge ourselves by getting on the front end of this thing, while people are still sharing information?" Obrock says. "A year or two from now, companies that have perfected their use of RFID technology won't be talking about it—they'll be using it for competitive advantage, and those that aren't on board will be experimenting in the dark."

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RFID Plans

Nucleus Research surveyed representatives from 22 manufacturing companies that use supply chain management systems.

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18% said they use RFID.
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12% said they have plans to implement RFID in the near future.
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70% said they have no plans to implement RFID in the next six months.
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69% of those that aren't using RFID said the cost needs to come down before they will consider it.
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25% of those that aren't using it cited investments in optical scanners and bar code readers as the primary source of their hesitancy.
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24% of all respondents said they have customers using RFID, and 27% said they have suppliers using it.

Brandel is a freelance writer in Grand Rapids, Mich. Contact her at mary.brandel@comcast.net.

Copyright © 2003 IDG Communications, Inc.

  
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