Case 1

Palas Acqua: Seeking Solution to Lower Distribution Cost

Water is the most important necessity for life. The drinking-water needs for individuals vary depending on the climate, physical activity and the body consitution, but for an average consumer it is estimated to be about 2–4 litres per day. Looking into the customer need of pure drinking water, Palas Acqua (PA) established its mineral water plant in central India at Nagpur. The growing number of cases of water-borne diseases, increasing water pollution, urbanization, scarcity of pure and safe drinking water, etc. has made bottled water business just like any other consumer item.

PA is a leading brand in mineral water market having presence in western and central India. Over the years many local brands have cropped in the market and gaining some share in market, which is growing at 10 per cent per annum. The mineral water is a commodity product and the demand is price elastic.

The supply chain manager of PA was preparing the next year's plan to find out changes in distribution system, which would help the company enhance its profitability. PA management wants to use the resources judiciously and release the funds to use elsewhere.

PA started as a regional bottled water company in Maharashtra and spread its market to two other states. Today the company's ‘Palas’ brand is popular in Maharashtra, Gujarat and Goa. As market demand grew, the company increased the volume it sold within the existing area and expanded its area of supply. As PA grew, it faced problems of profitability and customer service. The company had a large number of enquiries from new customers in the other states like Andhra Pradesh and Madhya Pradesh, it was uncertain as to how these could be profitably exploited. The problem with the company was the steadily rising distribution costs (trade discounts and logistics) in servicing more distant market areas.

Manufacturing

PA had a plant in Nagpur (Maharashtra) 550 kilometres from Mumbai, the commercial capital of India. Nagpur is well connected with other cities in India through road and rail. The mineral water met all the government regulations concerning purity and it is certified by the public health authorities. Clear plastic bottles with attached labels are used for filling the mineral water. These plastic bottles are sealed with tamper-proof opening. For bacteriological inspection, a sample from each production batch is removed and tested. Bottles are packed in corrugated paper cartons, which are placed on belt conveyors to move to warehouses. The cartons are stored in warehouses. These are stacked onto pallets and stored on racking storage system using fork lift trucks. The variable costs of production are Rs 1.3 for each bottle.

The advantage of PA's location is its excellent connectivity to all markets and thus lower manufacturing cost. The only concern was high distribution cost in comparison (logistics plus channel cost) to other local mineral water manufactures. All three states had a number of local producers of mineral water, who are confining their distribution in their home states. Overall fixed cost of the operation, including all manufacturing labour and bank interest on the outstanding loan, was Rs 12.5 crore.

Markets

The market for mineral water is steadily growing over the years. The reasons are growing awareness of not-so-pure (with contamination) water from municipal sources. With the increase in disposable income and growing consciousness about health, the market for pure bottled water is growing very fast. The market growth is 10 per cent per annum. However, consumption pattern is cyclic with seasons.

PA is largely catering to three major market segments. These are retail shops (small ones), large retail chains and restaurants. The high-end restaurant sector was dominated by premium brands but PA has a small share in that market also. The mid-and low-end restaurants were stocking PA and other local brands. In this segment, PA has considerable market share. In the stand-alone retail shop segment, PA is priced little higher than other local brands and consumers were also prepared to pay a higher price for PA. The retail market, which made up the bulk of the total volume sold was characterized by price discounts and distribution elasticity. The large retail chains were banking on price concessions and availability due to their bulk and continuous purchases. They were not willing to pay higher prices for PA products and would purchase local products rather than buying PA. In the price-sensitive retail market a large part of sales occurred during special offer periods. Purity of water with the certification was vital to customers and it would help the manufacturer to achieve a reasonable level of sale. The most preferred and moving pack size was 3.6 litres. In addition, large pack sizes were also preferred.

The retail market was served by many small and a few large players. The price offered was Rs 12 per bottle. Heavy discounts were common in the industry. Average discount offered was 18–20 per cent. The target price of PA was Rs 13 per bottle. Due to available price elasticity of Rs 8–10 for the manufacturer, the pricing and cost control was vital to business profitability.

As per research, customers are interested in the source of the water and the certification. Packaging (clear plastic bottle) is also perceived as another part of the product benefit, confirming the quality of the water and its purity. Bottled water generally have a long shelf life of over 8 months. However, with plastics bottle the taste of product alters, if exposed to strong sunlight over a long period of time. This reduces the shelf life by approximately 5 weeks. The second important element of the product benefit is attitudinal. In the restaurant sector, the attitudinal component is sophistication of the product. However, in the retail sector the traditional value of purity was more important. The name PA was associated with clear and pure water.

Retail shops (pop and mom) accounted for 20 per cent, retail chains 30 per cent and restaurants 50 per cent of PA's sales in the three states. The majority of outlets could hold 2–3 days’ stock but not more. Most outlets also demanded that suppliers support their products. PA had 40 depots spread across the three states. There was one more segment emerging in metro cities, that is, door delivery to households. Market surveys suggested that this part of the market was likely to grow rapidly in the B grade cities. Retail margins were typically around 15 per cent of the retail price.

Current Distribution

At present, PA is using trailers to distribute products in the three states. The distribution is done through 40 depots. The market size, the road distance in miles (one way), and the rail-link in miles (if in existence) are provided in Table 1.

Table 1 PAS Market Analysis

Each truck carries 9, 500 kilos of water—about 2, 500 bottles. PA had sales of Rs 6 crore last year. The overall annual fixed costs of the current operation were Rs 1.98 crore.

Future Plans

The company had identified two new markets for expansion. The statistics of these areas are in Table 2. The problems of supplying these areas would be acute. On the basis of the sales force volume forecast, additional vehicle mileage would be in excess than that of last year.

Table 2 New Centres for Development

Two distribution alternatives had been identified to reduce the cost. The first option was the use of rail. However, the rail speed was 50 kmph, but the network could, and did, operate over 24 hours. Rail cost was around Rs 1.2 per tonne per km of track. Because the company would have to deliver to the local railhead near the factory, and then transport product from the railhead at the destinations, with additional costs—storage and onward shipment. Storage handling and collection would cost around Rs 70 per tonne, by rail.

The second option was subcontracting the road transport operation. Three road transport companies quoted price based on full truck loads to the various distribution centres. Their quotes are given in Table 3.

Table 3 Quotes Submitted by the Three Transport Companies

PA had ambitious plans to increase its level of promotional investment in the following year. In the previous year, the company had spent Rs 1.2 per bottle on average in sales promotion, and in the current year planned to increase this to Rs 1.5 per bottle and with this, the company hopes to increase its market share by one point.

REVIEW QUESTIONS

1. Analyse different distribution alternatives for PA.
2. Discuss the pros and cons of different transportation modes PA has to choose from.
3. Choose the most cost-effective transport company from the available options.