In Search of RFID’s Sweet Spot

By Sunil Chopra and ManMohan S. Sodhi

March 3, 2007

Radio-frequency identification tagging seems like a great idea, promising to revolutionize how products move from factories to stores and into consumers’ hands. But amid the excitement, one question has remained unanswered: Do these tags actually make business sense?

Some retailers seeking to more precisely match inventory to customer demand are pushing the technology, in which chips carrying data are embedded in pallets or cases of merchandise, or even in the products themselves, and used as tracking devices.

Wal-Mart Inc., Target Corp. and Best Buy Co. are among chains with tagging initiatives under way. But because of the expense, some suppliers and even some retailers have taken a wait-and-see approach or chosen a partial rollout. While Wal-Mart is pushing RFID on the idea it eventually will save everyone money—it has required its 600 largest suppliers to affix the smart tags to cases and pallets sent to certain key test areas—some suppliers say they don’t expect any return on their RFID investments for years, if at all.

We set out to examine where in the supply chain an investment in radio-frequency tagging provides the biggest bang for the buck compared with older systems such as bar codes. We looked at the costs, benefits and risks of the technology at various stages in the supply chain and within the retail store itself.

Our conclusions: Upstream in the supply chain, we found low risks and low rewards when manufacturers slap electronic tags on pallets at their plants. Downstream, we found potentially high rewards, but also high risks and costs, when retailers use the tags to track individual products such as DVDs on store shelves. In between, we found that companies can cut receiving, handling and storage expenses, without incurring big costs or risks, when the tags are used to track cases of merchandise moving into stores. The business case for RFID is clearest at this point.

HOW IT WORKS

A basic radio-frequency identification system consists of the electronic tags that hold unique tracking information about an item, as well as tag readers. The reader emits radio signals to activate the tag, read the data and, in some cases, write data as well. Because nothing has to be physically scanned, the tags can be read faster than bar codes and in difficult conditions, including dust, snow and within packing material. The tag continually reports an item’s location, condition and status.

In 2005, the average cost of a single tag ranged from about 10 cents to 20 cents, with a typical reader going for about $1,000. The cost of a system depends upon the number of tags and readers required, so it grows as deployment progresses from pallets to cases to individual merchandise.

SUPPLY-CHAIN BENEFITS

We analyzed the impact of electronic tagging at various stages in the supply chain: planning, receiving and storage, manufacturing, delivering and returning. If a company is to justify an investment in RFID, it must see meaningful improvements in a variety of areas—for instance, faster loading and receiving, reduced transit and storage times, or less spoilage and counterfeiting. Here’s a look at the benefits in each of these areas:

• PLANNING Radio-frequency tags can help companies and their suppliers more easily share data, allowing them to create joint plans for replenishing stock. The tags can store more detailed data than bar codes, and the information they generate is instant—potentially alerting a manufacturer when the last case of its toothpaste moves from stockroom to grocery-store floor, for example. The information also is more precise because it takes human error out of the equation. But data-sharing isn’t the only thing preventing companies from establishing joint replenishment plans—for instance, the number of suppliers a company has can make it prohibitive. So, RFID’s benefits in planning are unlikely to be big enough to justify an investment.

• RECEIVING AND STORAGE Radio ID tagging is likely to improve an organization’s receiving and storage operations by increasing automation and improving a company’s ability to “see” stock stored in its warehouses.

Retailers are likely to benefit the most in terms of increased receiving efficiencies because they typically buy a large variety of products from many suppliers in cases, and shipments from a single supplier often contain multiple products. For example, RFID would eliminate the need to open up containers and scan the contents inside, saving on the time and labor needed to reconcile orders and deliveries.

Manufacturers that receive a large variety of high-value parts from their suppliers will benefit from case-level and, in some cases, item-level tagging. An auto company, for example, may find item-level RFID useful for receiving and tracking seats that must arrive at a car-assembly plant in the sequence of production. The tags could help ensure that the right seat is being placed in the right model, cutting down on assembly-line errors. RFID also could allow such a manufacturer to tie failures of finished goods to the individual components that went into them.

Manufacturers receiving a limited variety of products in large quantities—such as cereal makers that buy corn—are unlikely to benefit greatly from tagging because counting and tracking is less time-consuming when all cartons contain the same material.

When it comes to storage, RFID tags can improve inventory accuracy and help eliminate the need for stock checks. For example, Synthesis Exports, an Indian home-furnishings manufacturer that supplies U.S. retailers, carries out four stock checks a year, with an additional check by auditors. Stock checks take an average of two days and require significant manual labor. A case-level tagging system would eliminate the need for those stock checks. The ratio of benefits to costs is likely to be highest for companies that store a wide variety of products in cases. Their stock checks can be more labor-intensive because they have to track inventory for each product separately.

The value of tagging is likely to be high when used to keep track of supplies needed for maintenance, repairs and operations if these parts are expensive, take a long time to get and might result in a shutdown if not located. An airline, for example, may prevent a plane from being grounded by using RFID to locate a critical aircraft component quickly.

• MANUFACTURING When it comes to tasks that transform a product into a finished state, radio-frequency tagging is likely to add more value in factories where customized or multiple products are made. In those environments, there are more components to track and the sequence in which products are built may vary.

Vauxhall Motors Ltd., a unit of General Motors Corp. based in the United Kingdom, uses RFID to increase accuracy in manufacturing customized Astra models by attaching an RFID tag to each vehicle containing assembly details. The tag may explain what type of special parts or work the car needs, which can help shave labor costs by reducing mistakes.

Still, the additional benefits that RFID provides at this stage won’t be huge if a manufacturer already uses a system such as bar coding to cut down on factory errors.

For pharmaceutical makers required to track products and maintain compliance records, the benefits of RFID could be more pronounced. In the event of a recall, for example, a drug maker could use data stored on the tags to instantly pinpoint drugs from the bad batch and get them removed from the distribution chain.

Pfizer Inc. is affixing RFID tags to cases and bottles of its widely counterfeited erectile-dysfunction drug Viagra sold in the U.S. to help distributors confirm its pedigree. Similarly, cheese makers in Italy are embedding radio-frequency tags in wheels of Parmesan that tell where and when the cheese was made. But because of the expense of tagging individual items, such use of RFID can be justified only if it results in a significant reduction in counterfeit sales.

Pfizer says it is too early to measure RFID’s effectiveness as an anticounterfeiting tool because the technology hasn’t yet been implemented by all parties within its supply chain.

• DELIVERING Improved tracking with container-level, pallet-level or case-level tagging can pare supply-chain transit times, especially when products are being moved by more than one type of carrier during a single journey. Each time the mode of transportation changes, proof-of-delivery paperwork is required to complete the transfer. Case-level RFID can help automate that process, cutting down on labor costs and errors.

Chains that cross-dock shipments—a process in which merchandise from multiple suppliers is taken off incoming trucks at distribution centers and loaded directly onto trucks headed to stores—can save time and money by using the tags to help automate the sorting of merchandise and the necessary paperwork. The tags also can help track assets like crates, forklifts and trucks, and match the asset to what is being moved, for more efficient scheduling.

Computer maker Hewlett-Packard Co., which also sells RFID technology and services, says tagging has significantly lowered costs related to constructing and shipping pallets of mixed goods, such as printers and scanners, in some of its manufacturing and distribution operations. The company says that by deploying RFID, it eventually expects to save 80% on some labor costs at manufacturing and distribution sites in Virginia and Tennessee.

RFID can reduce losses related to spoilage by signaling which packages have been sitting in the warehouse the longest or when they are nearing expiration, allowing companies to move them out more quickly or sell them at a discount.

• RETURNING Processing returned products in bulk—in containers, pallets or cases, for example—may not benefit significantly from RFID because the flow of returns from retailers to suppliers isn’t that large compared with the flow of returns from consumers to retailers.

RETAIL-STORE BENEFITS

Ensuring that store shelves aren’t short of a product that is sitting in the back room is a critical issue for retailers. For a large chain like Wal-Mart, which stocks case quantities on shelves, case-level tagging combined with existing bar-code technology can be effective in ensuring that items are replenished on the shelves before they run out. Item-level tagging will clearly be more effective, though case-level tagging will capture a large part of the benefits.

Wal-Mart recently told The Wall Street Journal that the tags had improved product availability on store shelves and store managers worked more efficiently in replenishing inventories, but it wasn’t more specific.

Item-level tagging in the store is expensive, however. It might be justified for high-value items such as DVDs and apparel, which customers often pick up and leave in the wrong place in the store, resulting in an “out of stock” shelf even though the product hasn’t been purchased.

Embedding tags in high-value merchandise might help prevent theft, by setting off an alarm if the product is taken outside the store. Item-level tagging also could facilitate price changes in stores where product prices fluctuate based on age or expiration date, and improve the speed and accuracy of labor-intensive checkout processes.

RFID could help streamline returns from customers to retailers, tagging whether the items are defective and whether they should be discounted, discarded or simply put back on the shelf. The more efficient handling of returns can add to the value of item-level tagging, but it is unlikely to be big enough on its own to justify such an investment.

RISKS

Besides costs, there are other risks related to radio-frequency tagging and they, too, generally increase as implementation moves from pallets to cases to individual products. Among the biggest:

• The lack of a single industrywide standard for RFID raises serious problems when information needs to be read, shared and managed by multiple companies in a supply chain.
• Many small and midsize RFID providers may consolidate in the next few years or simply go out of business, so companies need to choose vendors with that in mind.
• Organizations must be prepared to manage the switch to an RFID system.
• Maintenance costs related to tagging may be high and support difficult to manage. A retailer, for example, may find that not all facilities have appropriate readers when it switches to second-generation tags.
• Testing or using RFID side by side with an older system such as bar codes can help measure the technology’s upside and ease the transition, but there is the risk that companies will continue with old processes instead of embracing new ones, according to Paul Fox, external-relations leader, global operations, at Procter & Gamble.
• Tags and readers aren’t foolproof, raising the risk that junk data will lead to junk decisions. Reader collision occurs when multiple readers attempt to read the same tag at the same time. Tag collision occurs when one reader receives signals that have reflected back from multiple tags at the same time. Next-generation technology promises to decrease such collisions, especially at the case level.
• RFID is a young technology, so it is likely to evolve. Any investment in the technology could become obsolete if the next generation is significantly different.
• A third party, whether commercially or otherwise motivated, could get access to proprietary data by breaking through RFID password protections.

For consumers, RFID provides few benefits but many risks, most related to the perceived loss of privacy. Consumers aren’t affected by case-level tagging, but they are by item-level tagging. Like Web “cookies” and credit-card information, item-level tags can be used to track what types of things you buy, how often you shop and the places you frequent. The information potentially could be used for marketing purposes, given to the government or stolen by hackers who want to sell the data to unauthorized parties.

The potential intrusiveness of RFID as it tracks and collects data has sparked a backlash from consumer-advocacy groups and raised concerns at the U.S. Government Accountability Office. Some companies have suggested that RFID tags be “killed” at the time of checkout to assuage privacy fears.

So what’s the smartest approach for those hesitant to charge ahead with a full rollout of radio-frequency tagging? After weighing the risks and costs associated with the technology, along with its benefits, our analysis suggests the best bet is to start with a case-level tagging program aimed at improving operations close to the retail end, such as receiving, handling and storage. That’s where a company will get maximum gain with minimum pain.

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