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September 15, 2003

Analysis: RFID and Wal-Mart

Analysis: RFID - Wal-Mart's Network EffectThe Network Effect

By Mark Roberti

Wal-Mart's new push to require its top 100 suppliers to use RFID tags on casesand pallettes of consumer goods shipped to its distribution centers and stores byJanuary 2005 will give the sensor technology its first broad, real-world test. There

are cost, technology and privacy concerns related to the broader use of thesesensors, but Wal-Mart's mandate represents a commitment to work out the kinks.

On June 11, Linda Dillman dropped a bomb on the retail industry. Wal-MartStores Inc.'s CIO announced that, as of January 2005, the world's largest retailerwould require its top 100 suppliers to put radio frequency identification (RFID)tags on all pallets and cases they ship to its distribution centers and stores. Thenews sent suppliers and competitors scrambling to learn about the wirelesstechnology, which enables companies to identify and track items in the supplychain automatically.

Then less than a month after Dillman's bombshell, just as executives werebeginning to grasp what it would mean for the retail industry and for suppliers,news reports revealed that Wal-Mart had cancelled a "smart-shelf" trial with TheGillette Co. The trial would have used RFID technology to monitor how manyrazor blades were on a store shelf in Brockton, Mass. Many media stories tookthis to mean that Wal-Mart was backing off its commitment to deploy RFID instores because of concerns raised by privacy advocates.

Next page: Why Wal-Mart halted its first RFID experiment.

Wal-Mart declined to comment on why it pulled the smart-shelf test. Butdeploying RFID in stores has never been a top priority for the retailer. In fact,Wal-Mart had delayed the trial numerous times since January, to the frustrationof Gillette executives.

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The trial was conceived as an experiment to see what kind of real-timeinformation could be gathered so that Wal-Mart and Gillette could begin to figureout how to use the data. Both companies knew it would not be economicallyviable to deploy the technology widely in stores for several more years. And Wal-

Mart didn't want to disrupt its in-store operations. Even a small test of the smartshelf would require resources to support the technology and personnel to makesure the test boxes and regular boxes, which look alike, didn't get intermingled.

Did negative press reports about the potential of using RFID to track consumers'actions play a role? Again, Wal-Mart would not comment on this. But it's quitepossible that the conservative company didn't want to risk the ire of privacyadvocates over a trial that wasn't critically important.

But the cancellation of the trial in no way undermined Wal-Mart's commitment to

RFID. To stem confusion in the industry, Wal-Mart hastily sent a letter to itssuppliers letting them know that the retailer remained committed to trackingpallets and cases with RFID technology beginning in 2005. Wal-Mart spokesmanTom Williams said the company wants to devote its attention to its ambitiousplan. "By 2006, we will roll it out with all suppliers," says Williams.

Industry experts believe that, given the huge commitment of IT and operationalresources necessary to fulfill its mandate, Wal-Mart could not afford to bedistracted by a smart-shelf test that wouldn't reap any immediate benefits.Edward Rerisi, director of research at Allied Business Intelligence Inc., a marketresearch company that focuses on wireless technologies, says he doesn't believe"anyone should read anything into" Wal-Mart's decision to back out of the smart-shelf pilot. "It was two separate applications, two separate projects," says Rerisi."You can't evaluate them in the same light."For the past two-and-a-half years, Wal-Mart has been working with the Auto-IDCenter, a nonprofit research organization based at the Massachusetts Institute ofTechnology, to develop and test RFID technology that will allow companies totrack goods using a universal Electronic Product Code (EPC). The Auto-IDCenter's long-term vision is for companies to use smart shelves to monitor howmany items are on each shelf. When inventory is low, software would signal astore manager that, say, more Tide detergent or Kellogg's Corn Flakes needs tobe brought from the storeroom. Readers in the storeroom would monitorinventory and alert the distribution center when more product is needed, and soon back through the supply chain. But Wal-Mart and other sponsors of the Auto-ID Center have always envisioned that it might take as long as ten years beforeRFID tags would become inexpensive enough to put on individual items instores.

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Many questions remain about how RFID technology will be deployed, such aswhat information will be shared between Wal-Mart and its many suppliers, andhow companies will track goods with both bar codes and RFID tags during the

transition period. But Wal-Mart is moving to deploy it at the pallet and case level,even before all the answers are known, because the technology has thecapability to improve efficiency, cut costs and boost sales.

Dillman's announcement caught many competitors and suppliers off guard. RFIDhas been used successfully in closed-loop supply chains, where a retailer, suchas Britain's Marks & Spencer Group, sells everything under its own brand. Butmost people thought the proposed EPC standard, which won't be formallyintroduced until this month, was still too new and too immature to be adopted inopen supply chains. At a recent trade association meeting for consumer productsmanufacturers, suppliers were concerned about just how much time they have to

comply. "Wal-Mart plans to hold a gathering for suppliers in November, but thatleaves us less than a year to do this. We won't want to deploy new technologiesin November and December, because that's the big selling season," says asenior executive at one of Wal-Mart's largest suppliers, who asked not to beidentified.

The importance of Wal-Mart's decision is hard to overestimate. "You can counton one hand the number of retailers big enough to force a whole industry toadopt a new technology within a constrained amount of time," John Fontanella,vice president of research at AMR Research wrote in a recent report. "Wal-Martis biggest of them all."Many people now expect RFID use at the pallet and case level to take off rapidlybecause of something economists call the "network effect," which basically saysthat the more people use a physical network (say, the Internet) or shared service(eBay), the more valuable it becomes. That encourages even more people to usethe network, creating exponential growth.

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The Wal-Mart RFID mandate means its top 100 suppliers not only have to puttags on pallets and cases, they must also install RFID readers in theirmanufacturing facilities, warehouses and distribution centers. They, in turn, canrequire their suppliers to tag shipments and so on through the supply chain.Since Wal-Mart sells auto parts, clothes, groceries, pharmaceuticals andentertainment products, the network can quickly spread to many industries. Andas more suppliers adopt the technology, it will make more sense for other



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retailers to take advantage of RFID, which will drive down the cost of tags andreaders, encouraging still more companies to jump in.

Today, RFID tags cost anywhere from 40 cents to a dollar, depending on the sizeof an order and the features of the tag (amount of memory, whether it is read-

only or read-write and so on). This cost will be borne by Wal-Mart's suppliers.Could they refuse to comply with the retailer's demands? "You can't do that if 10percent to 40 percent of your business is going through Wal-Mart," says PeteAbell, cofounder of the ePC Group Ltd., an independent consulting company,and the former head of AMR Research's retail practice. And Wal-Mart's Dillmanhas said that companies that don't comply will be fined.

Wal-Mart is unlikely to back off its requirement, because the retailer is convincedthe benefits are huge. Financial analysts agree. Sanford C. Bernstein & Co., aNew York investment research house, estimates that Wal-Mart could save nearly

$8.4 billion per year when RFID is fully deployed throughout its supply chain andin stores.

With those kinds of benefits in sight, it's not hard to understand why the retailer ispushing ahead so aggressively. The ePC Group's Abell says that in the mid-1980s, when most grocery stores were rolling out bar code technology slowly,Wal-Mart dispatched 70 teams to install scanners in its stores as quickly aspossible. And he expects the retailer to do the same with RFID for its supplychain. "They understood that the sooner you got the stores up, the sooner yougot the benefits," says Abell. "I see the same thing happening now with EPCtechnology."

Wal-Mart has been studying the potential of RFID for more than 12 years. It hasa facility in Rogers, Ark., in which it tests tags and readers from various vendorsand studies how the performance of these products is affected by theenvironments in its distribution centers and storerooms. Wal-Mart will explain toits suppliers what they need to do to fulfill the retailer's requirements, but afterthat, they're on their own.

Competitors and suppliers who are just beginning to look at this technology havea huge task in front of them if they want to be fast followers behind the leaders.RFID is not a simple plug-and-play technology. It has improved a great deal withthe advent of UHF tags. But while UHF waves can pass through cardboard andpaper packaging, they bounce off metal, creating false or failed reads, and theyare absorbed by water.

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A supplier can't simply slap a smart labelone with an RFID tag embedded in iton 60 cases of coffee cans, stack the cases randomly on a pallet and readevery tag as a forklift carries the pallet through a dock door at five miles per hour.Retailers are going to have to figure out sensible solutions for hundreds ofproducts with high water content or that are made of metal. And suppliers may

have to follow different compliance requirements for different retailers. Solutionsmight include using a specific type of tag, placing the tag in a precise location onthe case and arranging the cases in a special configuration on a pallet.

The changes wrought by RFID systems will affect virtually everyone in thecompanyfrom the forklift operator to the head of logisticsbut perhaps nonemore than those in the IT department. The whole point of using RFID is to enablecompanies to gather real-time data automatically. The challenge will be to figureout ways to filter, use and share that data.

EPC tags contain only a serial number. That means for the tags to be of anyvalue, suppliers will have to create a database that contains information aboutwhat the item is, where it was made, what its expiration date is. Retailers willneed to figure out exactly what information they need, what format it should be inand how it should be shared. Retailers and suppliers will have to work together tosolve these issues.

And it's not clear how companies will transition from the universal product codeincorporated in bar codes to EPC tags. The Uniform Code Council Inc., whichmanages the UPC and has taken responsibility for commercializing EPCtechnology, has not spelled out a clear migration path for retailers, suppliers andsoftware vendors. Bernie Hogan, the UCC's chief technology officer, says theorganization has a draft road map. But it wants to work through some actualdeployments with companies, such as Wal-Mart, to fine-tune its road map beforemaking it public.

Once a road map is published, software vendors will have to create new fields tocope with the data. Many companies, including Manhattan Associates Inc.,Provia Software Inc., RedPrairie Corp. and SAP, are adding software modules orupgrading their products to cope with the serial numbers in RFID tags. But thesesolutions still require suppliers and retailers to deploy middleware that managesthe huge amount of data coming from the readers. CIOs will have to devise waysto filter out false or redundant reads and pass on only useful information toenterprise applications. And they'll have to work with line managers more closelythan ever to shape these systems. For instance, IT and business managers willhave to figure out when inventory in the storeroom or warehouse needs to bereplenished. Set the trigger too low and you'll run out of product; set it too highand you'll wind up with excess inventory.



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CIOs at retail companies also will have to work with their counterparts in theirsupply base to find ways to get product to the stores before the stores are soldout of an item. Studies show that products are out of stock in the grocery andmass-merchandise sector an average of 7 percent of the time. Procter & GambleCo. has commissioned research that reveals that out-of-stocks on some fast-

moving items can be as high as 17 percent.

As Wal-Mart pushes forward with RFID technology, thenetwork effect is likely to spread quickly. If P&G is taggingpallets and cases for Wal-Mart, it's not difficult for P&G to dothe same for Target Corp. and other retail partners. Thatprovides incentives for other retailers to follow Wal-Mart'slead.

And the benefits of RFID won't be limited to the retail and consumer goods

industries. Wal-Mart is the world's largest tire retailer. The Transportation RecallEnhancement, Accountability, and Documentation (TREAD) Act requiresautomakers to be able to uniquely identify tires on cars from the 2004 modelyear, so the tires can be recalled more effectively. If Wal-Mart uses EPC tags ontires, it would make sense for automakers to use the same tags, which will beless expensive than specialized tags produced in much smaller volumes.

As more companies adopt the technology, the price of RFID tags and readers willdrop sharply and all kinds of new applications will become economically viable.Manufacturers will be able to put tags on parts to enable them to more efficientlycustomize their products. Pharmaceutical companies will be able to ensure that

their drug products are not counterfeited. Farm products will be tracked from thestable to the table, ensuring freshness and the ability to quickly recall taintedmeat. The improvement in productivity will dwarf the gains seen during theInternet era. But given the complexity of implementing this technology,companies that don't move quickly will wind up at a severe competitivedisadvantage.

Mark Roberti is founder and editor of RFID Journal, an independent Web sitethat covers business applications of RFID technology.

Analysis: RFID and Wal-Mart

Analysis: RFID - Wal-Mart's Network Effect (continued)The ability to know where every item is in the supply chain and store could saveretailers billions of dollars per year. Here's an estimate of what Wal-Mart mightsave annually when RFID technology is deployed throughout its operations.


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$6.7 Billion: Eliminating the need to have people scan bar codes on pallets andcases in the supply chain and on items in the store reduces labor costs by 15percent.$600 Million: Even with the most efficient supply chain on earth, Wal-Mart suffersout-of-stocks. The company boosts its bottom line by using smart shelves to

monitor on-shelf availability.$575 Million:Knowing where products are at all times makes it harder foremployees to steal goods from warehouses. Scanning products automaticallyreduces administrative error and vendor fraud.$300 Million: Better tracking of the more than 1 billion pallets and cases thatmove through its distribution centers each year produces significant savings.$180 Million: Improved visibility of what products are in the supply chain-in itsown distribution centers and its suppliers' warehouses-lets Wal-Mart reduce itsinventory and the annual cost of carrying that inventory.$8.35 Billion: Total pre-tax saving is higher than the total revenue of more thanhalf the companies on the Fortune 500.


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