Delivery guarantees and the interdependence of marketing and operations

Production and Operations Management, Fall 2002 by Chatterjee, Subimal, Slotnick, Susan A, Sobel, Matthew J

DELIVERY GUARANTEES AND THE INTERDEPENDENCE OF MARKETING AND OPERATIONS

Delivery guarantees are an important element in a customer satisfaction program. When setting delivery guarantees, a firm must consider customer expectations as well as operational constraints. We develop a profit-maximization model in which a firm's sales organization, with incomplete information on operations' status, solicits orders and quotes delivery dates. If obtained, orders are processed in a make-to-order facility, after which revenue is received, minus tardiness penalty if the delivery was later than quoted. We specify conditions for an optimal log-linear decision rule and provide exact expressions for its effect on arrival rate, mean processing time, and mean cycle time. (DUE-DATE; LEAD-TIME; PERFORMANCE GUARANTEE; QUEUE)

1. Introduction

1.1. Background

In recent years, with quality movements firmly entrenched in the marketplace, many companies use service guarantees to differentiate themselves from their competitors in the delivery of customer satisfaction (Etorre 1994). While such guarantees can take many forms, ranging from simple "money back" guarantees to more complex "performance" guarantees, to be effective, a guarantee must be easy to explain, simple to administer, and convenient for the customer to collect (Hart 1988; Bell 1993). A delivery guarantee, where the sales manager commits to perform the service or deliver the product within a specified period of time or else give the customer a discount on the price, seems to meet these criteria well.

Indeed, many companies have gained national prominence through their delivery guarantees. For example, Domino's Pizza owes much of its success to its famous though ill-fated promise to deliver its pizza in 30 minutes or else give the customer a $3 discount. Before it went out of business in July 2001, Webvan, the pioneer of the Internet delivery service for groceries, pet food, books, flowers, and children's toys, would allow customers to select a delivery time 7 days in advance and guarantee that delivery would occur within 30 minutes of the customers' chosen time (Krizner 2000). Federal Express' next-day delivery guarantee, "absolutely, positively by 10:30 AM," initially set the company apart from competitors like UPS and Airborne Express. TWA's "on time or else" guarantee promises a customer 1,000 frequent flier miles if the flight is more than 15 minutes late. Similarly, travelers who purchase tickets on selected airlines through Biztravel's Web site can apply for refunds of $100 if their planes arrive at their destinations more than 30 minutes late and $200 for delays of 1 hour or more (Carey 2000). When Amtrak offered disgruntled passengers free trip certificates as part of their "unconditional service guarantee," it found lateness to be the most common reason among passengers invoking the guarantee (Wald 2000). To counter reported declines in customer satisfaction, Wells Fargo & Co. initiated a service guarantee that promised to pay $5 to any customer who waited more than 5 minutes in a teller line (Chase 1997). Delivery guarantees have become such a popular marketing tool that firms sometimes brand them for greater recognition [i.e., using names like "touchdown guarantee" (Hill 1989)]. With the exception of the Internet travel refund, which uses a sliding scale of lateness to determine how much to reimburse customers, these examples of service guarantees refund customers a fixed amount, no matter how late the delivery. In the manufacturing arena, there is more likely to be a penalty that is proportional to the amount of time that the delivery is late, for example, 0.1% of the contract price for each day's delay (Shapiro, Moriarty, and Cline 1992).

Setting delivery guarantees, however, is not a simple matter. Without considering the interdependence between marketing and operations functions, firms may find themselves committing early to a delivery commitment, only to find later that operational constraints prevent them from meeting such guarantees. The result may be a belated withdrawal of the offer, accompanied by acute embarrassment and loss of market credibility. For example, Allied Signal Plastics had to pull the 48-hour delivery guarantee of its popular resins within days of the announcement when the company found that manufacturing and inventory constraints precluded it from meeting that guarantee (Freeman 1996).

Firms must also consider the cost-benefit tradeoffs that are embodied within the delivery guarantees. For example, firms may rush into delivery guarantees to match or beat similar promises from competitors, only to find themselves paying unacceptable amounts of penalties because they cannot meet their guarantees. During the 1999 holiday season, Internet retailers like Macys.com and Toysrus.com, feeling the pressure of competition, guaranteed Christmas deliveries to online customers even when some of them had no reasonable hopes of meeting those guarantees (e.g., the ordered products were out of stock). The Federal Trade Commission fined them $1.5 million for their false promises (Emert 2000). On the other hand, firms may be too cautious in their approach, quoting long (and attainable) delivery dates only to find their customers switching to competitors (Kaufman 1996).