The Over-Under of Inventory Buying: A Response

 

A recent survey of 200 “senior decision makers” in U.S. retail companies conducted by Coresight Research and Celect, found that 43% of respondents chose overbuying as a company challenge, and 36% chose underbuying. The survey went on to say that those respondents using “manual inventory management processes were more likely to say they were struggling” with issues related to over or under buying.

Now that this survey has actually quantified over and underbuying as a problem, what is the next step?  Given the vast number of solutions available at the push of a button for almost any problem facing us today, I find it inconceivable why so many retailers choose to struggle with an issue that is relatively simple to identify and affordable to remedy. Having invested the last forty years working for forecasting companies that offer automated inventory planning and open-to-buy models along with ongoing consulting by industry experts, there is no reason I can think of as to why a merchant would not consider outsourcing this function. What else needs to change for retailers to use the correct data to make more informed buying decisions?

Among common reasons (aka excuses) that I often hear for not utilizing an outside company for merchandise planning include ego, lack of accurate data, and cost.

A strong, healthy ego or belief in oneself is certainly one major cornerstone of every successful entrepreneur and clearly every independent retailer. However, once self-confidence becomes so over-inflated that it is detrimental to the organization, it is important that management recognize this and look for an alternative independent, outside perspective.

If a company lacks accurate data to develop and maintain a plan, either due to deficiencies in the point-of-sale system or lack of understanding of how to use the system (often the case), inventory mishaps are likely to occur. The easy remedy for this is to invest in a system that will actually provide the data you need after consulting with informed sources, then take the time to learn how to use it. The initial “cost” pales in comparison to the money being left on the table due to poor buying decisions resulting from inadequate data or no data at all.

Here’s a question to ponder. If you were struggling with cash flow issues due to past buying mistakes, shrinking margins as a result of too many markdowns, or out of balance inventories hindering the store’s upside volume potential, would you be willing to invest a reasonable amount of money to alleviate those issues? Let me share a typical example that I often encounter. I was approached by a store with a sales volume of just over a million dollars. The margins were fine and the operating expenses were in line with industry norms. The issue was cash flow. When the merchandising data was analyzed, the problem was obvious. There was so much old merchandise that the store was losing customers. Most of the operating cash was tied up in the inventory. This problem was caused by buying more merchandise than the store could sell profitably; the classic definition of overbuying. Overbuying is the result of either A) not having an adequate merchandise plan with which to make sound buying decisions by classification or B) not following the plan.

The store had an average inventory of approximately $800,000 @ retail, a large percentage being from past seasons. This worked out to be an inventory turnover of 1.25 times annually. Based on the mix of merchandise, it was determined that an initial turnover goal of 2.7 was achievable and a strategy was put into place to liquidate the old merchandise and begin buying the right amount in the correct classifications.  After the first year of working with this retailer, the inventory was reduced by approximately $430,000 @ retail or $215,000 @ cost.  The sales started rising as new customers began finding the store through word of mouth, and old customers returned. The margins did decrease temporarily due to clearance markdowns needed to move the old merchandise. However, the cash was so much better that the owner could hardly believe the transformation. The line of credit was paid off and the store’s buyers go to market armed with a solid plan knowing exactly how much to buy, when to land it and when to mark it down.

This example is typical of first year results. Most retailers will end up spending less on inventory, but wind up doing more business because the dollars are invested where they are needed most. On average a minimum three-time return-on-investment is typical for every dollar spent on merchandise planning services according to Marc Weiss, President of Management-One.

I see examples such as this all the time. Some stores choose to take advantage of the help they are offered and regain control of their stores and, by extension, their lives. Others unfortunately do not and almost always suffer the consequences. I often refer to the old definition of insanity which is repeating the same behavior time and time again in anticipation of a more favorable outcome.

Since roughly 60% of non-grocery items were sold at full price in 2018, resulting in an estimated $300 billion in lost revenues, it is easy to deduce that poor buying decisions can be expensive. The good news however, is that with the increased utilization of technology, “specifically better forecasting tools that leverage machine learning, that can help retailers know what to keep in stock and when.” As trite as it may sound, failing to plan IS planning to fail.  You decide!

The Psychology of Price

A quick search on Google and you will find millions of entries on the topics of pricing psychology and pricing strategies. I have elected to recap strategies that, at the very least, most retailers should consider to determine price.

In a practice still prevalent today, the retail price of an item is often determined by a buyer or receiving person applying a formula to the landed cost of an item in order to determine what it should sell for. Should cost really be the determining factor in what a customer is willing to pay? Does it have anything at all to do with perceived value? Of course not, yet we see this all the time.
I have questioned retailers about this topic for years and always get the same responses. Most typical are, “double the cost and add $2 (supposedly to cover shipping),” or “multiply the cost by 2.2.”
One strategy that I have used with buyers at market was to determine the selling price prior to knowing the cost. To do this effectively, a retail buyer must answer the question, “What will our customers be willing to pay for the item?” Once the cost is revealed, a determination can easily be made if the item fits within the company’s markup strategy or does not.

Let’s discuss some additional strategies that you might consider as you determine price going forward.
• Remove the comma // Research has found that removing commas may make the price seem lower. For example, $1,499 vs $1499.
• Round price // Round prices are more fluently processed as opposed to non-rounded price points. Consumers can process a round price quickly. Non-round prices need more mental resources to process. Round prices are also more effective for emotional purchases, with this caveat: Try when possible to avoid price intervals like $100 or $500, as the assumption may be that they are artificially high and plucked out of thin air.
• Use of a premium price to set an expectation of excellence // The iPhone X selling for between $999-$1,149 is significantly higher than past models. Approaching or breaching the $1,000 threshold is noteworthy. Boosting prices into the four- digit realm crosses an important psychological barrier.
Here’s another example that you may remember. In 1994, after a 14-year hiatus from their 1980 well-publicized breakup, The Eagles released a new album and embarked on a world tour. What was unique was that they were the first rock and roll band to break the $100 ceiling for concert prices. Eagles manager Irving Azoff stated that this had nothing to do with supply and demand, but rather a statement of quality. Fans would once again get to see and hear a great American rock-and-roll band, not a washed up “oldies” show. This was a fascinating use of price as it set a belief of excellence in the mind of the consumer. I saw this show … and it delivered!
• Discount pricing // This is the high/low pricing strategy. Was $70, now $35. You save $35. It is important when using this strategy to frame the sale around the savings versus the amount being spent.
• Reduce the pain of paying // Uber revolutionized the taxi industry. With traditional taxi rides, you watch the meter increase with each minute stuck in traffic or each mile traveled. This evokes a painful sensation. With Uber, you know what the trip will cost before you start, and it’s billed right to your credit card. The perception of payment is also distorted by the use of gift cards and casino chips, two additional payment methods have that have created a separation between the customer’s money and the payment.
• Remove the $ // $$$ can remind some people of financial pain. Ever notice that some restaurants are now pricing menu items without the $?
The next time you are tempted to slap up the 25 percent off sign and call it good, remember that percentage off pricing is irritating to the customer. It is tremendously overused and less profitable to the retailer.

The psychology of pricing is a fascinating topic. I would encourage all retailers to experiment with a few of the points discussed in this article. You might discover a more profitable way of pricing your products

You Can’t Afford To Make Every Sale

(Having trouble with assortment creep? Contact me, I can help!)

Naturally all of us would like to sell everyone that shows interest in our products. After all, that is exactly why we are in business in the first place. In the retail business, trying to sell everyone that comes into your store or finds you on the Web would be unrealistic and you most likely would go broke trying.

The old saying, “you can’t be everything to everybody” comes to mind. All good retailers have an identity or image and target a certain demographic of likely customers to market to. You certainly wouldn’t go into a store specializing in work boots looking for water sandals just as you wouldn’t expect to find cowboy boots in an outdoor store. Even the broadest assortment that might be found in an outdoor store carrying many different departments is governed to a certain extent by consumer demographics, size of store, or even the financial strength of the owner.

Stores that attempt to please everybody so as to not miss a sale, over time end up with a condition I refer to as “assortment creep”. The symptoms are easy to spot; lots of random inventory, duplications, broken sizes on popular styles, markdown opportunities from past seasons that may have been missed. In other words, a whole lot of nothing! This is difficult to spot on paper or by just reviewing inventory reports. You may observe that the stock levels are over plan, but sales are slipping for no obvious reason.

One solution I often share with clients who are struggling with this problem is the creation of a “model stock”. The easiest way to picture this is by starting from scratch. Assume you are opening a new location or you have nothing at all in the particular category. In the perfect world, you would map out exactly the way this should look. What lines you wish to carry, how many styles, what sizes and colors, a varied assortment of price points, etc. Next, you will need to extend out the dollars and see how much you have at retail and compare this number to your open-to-buy plan. If you are way over or short, you may have to adjust the model by adding or deleting. Congratulations, you have just completed step one of your assortment plan.

Step two is to compare your “model” to what you currently have. This is where the process gets interesting. You will find that over time, you have added lines that perhaps now are not important. You might find that you have been filling into styles that once valid, are now slow turning and may no longer be relevant. You might even discover that you have been ordering too many sizes that in reality end up on the sale rack or worse yet are carried over from year to year. What your goal should be is simply to put your inventory back into balance. In essence, this process is much like rebalancing your stock portfolio or 401k.

Once you have determined where the holes in your plan exist, it is now time to correct the problem. This is the final step in the process. Now that you have identified items that are not part of your model plan, mark them down immediately and turn them into cash. Use the funds generated by the cleanup to reorder the sizes that may be missing from the key styles that you wish to go forward with.

Creating model stocks works very well with almost every category of merchandise that has the ability to be reordered or filled into. Try this concept if you find yourself suffering from assortment creep. You will be surprised how many fewer customers walk out empty handed.

Manage The Bottom 30% for Better GMROI

I encourage every retailer to actively engage with all key vendors. The ideas in this post will help.

Jack Welch, the former GE leader, was widely known for his 10% rule. He would insist that the workforce was culled by 10% every year as part of a continuous improvement process. The genius of the policy was not necessarily that you got rid of the dead weight, but that it forced his managers to make a decision about how to deal with under-performing personnel.

A similar discipline should be adopted for inventory performance. I work with a store that is very diligent about this process and the results speak for themselves with better margins, double-digit sales increases, sales per square foot numbers that are 2.5 times the NSRA average, and an improvement in inventory turnover that is double the industry average. Their mantra is simple, they aggressively manage the bottom 30% of their inventory, along with vendor engagement.

Here’s How It Works

Every week the store’s buyers send vendor sales representatives reports detailing the activity (or lack thereof) of the styles being carried from their respective lines. If there isn’t acceptable sales performance within a 30 period, the store requests that the vendor take action. This action might be a swap out for another style, increased advertising allowances, clinics and incentives for sales associates, or in extreme cases a total return of the product. Obviously, consideration is given to any number of circumstances that could possibly affect sales, including seasonality and merchandise received with terms to name two. The vendors are asked to manage the bottom 30% of the styles purchased for that season. The store manages to remaining 70%.

This retailer evaluates vendors based on historical criteria that includes sales, margins, turn and GMROI. All vendors are reviewed in person every six months and are given a vendor report card. Vendors that meet and exceed the benchmarking numbers are rewarded with bigger orders. Vendors that fall short of expectations are dealt with in the following manner: the first 10% below the cutoff are contacted to see what can be done to improve performance. The middle 10% are put on notice. This is like retail purgatory. Things could go one of two ways. Either noticeable improvement is made or they could be the next to go. There are no surprises this way. The very bottom 10% are informed that the relationship has run its course and that they should move their success elsewhere. The management of the “bottom 30%” is an ongoing discipline that everyone in the company adheres to.

If there is no significant response from a particular vendor, the merchandise manager or owner may need to get involved to force action. After 45 to 60 days, if there is still no resolve and if sales do not pick up to a respectable level, the first markdown is taken. This action will most likely land the vendor in the bottom 10% range. The result of this ongoing analysis is that the store does not end up putting additional funding into lines that are not productive. Let’s say the average GMROI for a given classification is 2.7. Any line with performance less than 2.7 is identified via the POS reports. Things either improve according to the schedule outlined previously or the vendor is dropped, the merchandise liquidated, and the money used to reorder top sellers on lines that are performing.

Narrow the Resource Structure

This process helps the store to narrow the resource structure. If for example, Vendor A is responsible for $100,000 in sales and Vendor B generates only $5000 in annual revenue, it might well be decided to discontinue Vendor B if is determined that more volume cannot be generated, even if Vendor B is profitable. The additional dollars are then added to Vendor A.

This retailer is always on the hunt for new lines. A significant portion of open-to-buy dollars are kept available for reorders and of hot trending styles, fill-ins on basic inventory, an off-price buy, or a new line that needs to be “tested”.

Another common request from this store is that when possible the vendors are asked to “locker stock” inventory. Basically, this requires the vendor to warehouse the backup inventory being reordered weekly instead of the store having to. This practice alone reduces inventory and increase turnover.

In years past, this type of approach may have been considered too aggressive for some. In today’s retail environment, managing vendor assortment is essential. Brand loyalty must be a win-win. Gone are the days when retailers should be expected to buy a line unconditionally that is under-performing simply because they always have. Retailers cannot afford to carry a line for a handful of customers who, in some cases, don’t buy until the line is on sale anyway. The resource profits when the store profits. If the store is not profitable with a particular line, the sooner the problem is dealt with, the better.