Inventory Management – 10 Guidelines To Insure That “Cash is King”

“Too much” or “not enough”, that's the balancing act required to effectively manage inventory. If you end up with “too much” it can mean discounting. This not only hurts your margins for the season, it can also hurt your brand image for seasons to come. If you “don’t have enough” you will lose sales and possibly “goodwill” with customers for future purchases. The art and science of good inventory management balances the two. “Cash is king”, especially lately. Strong sales produce cash and tight inventory management preserves cash.  The following guidelines help with both:

  1. Inventory levels are dependent on forecast accuracy. Forecasts will never be 100% correct. So, work to improve forecast accuracy. But, at the same time work to manage the “inaccuracies” or the “too much” or “not enough” caused by over forecasting or under forecasting. A wholesale client of mine was so intensely “sales driven” that they focused solely on “not” losing a sale despite inventory management or margin implications. I worked with them to better understand and balance all aspects of inventory management.
  2. Good inventory management cannot be done in a silo. Assortment planning and channels of distribution plans – store floorsets, catalog lay outs, e-commerce promotions, and wholesale customers – are all part of the equation and must be key input. I worked with a catalog client who had the inventory management function off by itself in a procurement department. They had tremendous excess inventory. The first thing I did was set up cross – functional processes and responsibilities. This helped to reduce inventory immediately.
  3. When buying inventory or forecasting, it’s good to remember that sales people and product people are optimistic. Clients and products are their “babies”. Each time I work on a reorganization with a client I always build in “check and balances” to address this.
  4. Strong cross-functional processes are crucial to solid inventory management. Skilled people are even better. A “new system” rarely solves your problems but is often required.  A straightforward calendar driven by lead times, with key milestones, owners, and dates has helped many of my retail and wholesale clients. An “Open to Buy” (MRP – wholesale/mgf equivalent) must be put in place and/or actively managed. Twice I have seen clients severely over inventory themselves by mixing up their cost basis inventory with retail basis sales – beware.
  5. “Tops down” and “bottoms up” - stores, catalogs, or customers - is the way to go. This is especially true for bricks and mortar retail stores at the sku level. Stores must have the proper skus to sell and they must have some sort of minimum presentation. One retail client of mine bought at the “total level”. When the goods came in they did not have enough skus to allocate to all stores. I worked with them on doing “bottoms up” buying and forecasting along with “tops down” giving stores better coverage for better sales.
  6. Always have contingencies. Things will never turn out the way you plan so have contingencies and “trigger dates”. These contingencies need to include the “upside” – dual sourcing and raw materials etc – as well as the “downside” - sales events, cancellations etc.
  7. Inventory does not get “better” with time. If a product or certain category is not performing deal with it now. It is not going to get better with time – unless it’s wine. A retail client of mine in the fashion business had kept so many styles around without discounting that their website had way too many skus. Customers never found the old product. I worked with them to clear out these styles and put a process in place to keep the assortment current.
  8.  “Inventory aging” is ok in fashionable, seasonal or perishable categories. My all time favorite example of mis-used aging is automatic markdowns taken on “men’s basic white shirts” simply because of an aging code. This makes no sense. As long as you have the cash to carry excess in basics – do it – you won’t miss a sale.
  9. Inventory metrics must be included in performance plans. Annual inventory turn is the primary measure at a category or company level. Sell through, sales stock (or stock to sales), weeks of supply (or days) works well to insure good management at the sku level. These metrics need to be included in product and sales people’s performance plans as well as the inventory management group.
  10. The shorter the lead time the better. But, don’t mistake this. It does not solve inventory management issues. It simply helps with reaction time. Many of my clients have implemented initiatives to shorten lead times – a good thing – but I also work with them to improve inventory management 1-9 above.

I’d suggest enrolling your entire team in the guidelines above to insure success. Good luck. I can be contacted at Janice@jlsearsconsulting.com.  I’d be happy to hear about your inventory management needs.

Key Metrics (KPI’s) for Retail, Catalog, E-commerce, and Wholesale Organizations-Part #2

Key metrics are a crucial element in the management of any bricks & mortar, catalog, E-commerce or wholesale organization from my perspective. The metrics and their values or goals must be developed during the business planning process and then utilized in individual performance plans in order to achieve the plan (Please see blog titled “Six Steps to Achieving Your Business Plan”).  In my practice, I often see a lack of connection and understanding between the business plan, the metrics, and individual performance plans. This creates an opportunity to increase success stories for organizations and individuals.

Key metrics fall into the following categories and should be shared across functional teams with different weighting depending on the impact on the metric by function:

                Sales and Demand

                Productivity

                Margin and Profit

                Inventory

(The list below looks long but really encompasses most metrics utilized to plan and manage a business.  I usually suggest no more than 4 key metrics for performance reviews though.) 

In Part #1 we talked about key metrics for traditional bricks and mortar and we began our discussion of the direct to consumer business with Catalog. Now let’s talk about additional nuances for the Direct to Consumer E-commerce world. Overall this business operates similar to Bricks & Mortar retail on the front end (aka a virtual store)although customer data is more readily available but operates like the Catalog business on the back end (aka Direct to Consumer logistics model):

Demand and Sales

  1. Demand- Demand measures all potential customer sales regardless of stock outs. I believe there is an opportunity in E-Commerce to capture more true Demand without risking customer dissatisfaction. Most organizations I have seen capture Gross Sales (sometimes only Net Sales) per the above. If more of true Demand was captured future sales could be more easily maximized.
  2. Gross Sales @ Retail-Generally means total sales dollars prior to returns and markdowns.
  3. Returns-Dollar amount of goods returned-often stated as a % of Gross Sales. A benchmark might be a 10% rate.
  4. Markdowns-Dollar amount of the discount a customer receives @ retail-often stated as a % of Gross Sales. A benchmark might be 20% markdowns (which is different than 20% off depending  whether it’s stated as a % of gross or net sales).Sometimes markdowns are taken when sold (POS)and sometimes inventory is de-valued with a markdown prior to being sold.         
  5. Net Sales @ Retail -Gross Sales after returns and markdowns are subtracted

Productivity

  1. Traffic (visits or sessions) –This is just like the traffic or customers entering a bricks and mortar store except that it’s on line traffic. It’s similar to circulation in the Catalog world. It really measures how many “eyeballs” are viewing or shopping your merchandise or services. Traffic in the E-Commerce world is generally generated from SEO (Search Engine Optimization), PPC (Pay Per Click), Affiliate Marketing, Organic Search and Catalogs. These traffic generation methods should be measured for their productivity in an E-Commerce organization in order to maximize traffic profitably
  2. Conversion-As in bricks and mortar or catalog this measures how many people are actually buying out of those visiting your site. In the E-Commerce world this generally is a % of visits or sessions. Some are now measuring this as a % of page views per session.
  3. The Following productivity metrics are the same for traditional bricks and mortar, catalog and E-Commerce.
    1. Sales per Style-Gross sales divided by the number of styles. This gives a benchmark of what the average style produces and is a good metric to review in comparing departments and or when growing or shrinking a category.
    2. Average Order Size and Average Units per order- This is net sales(after markdowns) divided by the number of orders. The larger the order size usually the more profitable since logistics costs then become a smaller %. Average Units per order tells you that the average order size of $150 is made up of 2.5 items per order.
    3. Average Unit Retail – Net Sales (after markdowns) divided by number of units sold. It’s a good metric to compare categories (ie average sale of a top versus a outerwear piece or a fishing rod with a piece of tackle). This really tells you what your customer is willing to pay for an item versus where it is priced. They might be willing to pay $100 for a jacket and $50 for a top. Note: Sometimes organizations calculate the Average Unit Retail of on hand inventory which is not apples to apples with this figure because of markdowns.  In the above example a jacket might be $120 and the top inventory may be $60.
  4. Customer productivity-This is a key element and warrants it’s own discussion. Similar to the Catalog world, E-commerce easily captures customer data. Generally, this data is segmented by frequency (new vs repeat customers) and total purchases. This data can be utilized to better market to existing customers (especially when it goes down to the product category level) or to get new customers (see traffic above).
  5. Merchandising productivity-The productivity of space or placement of product (home page, banner etc) has not been a standard metric in the E-commerce world like in the Catalog world. From my perspective there is an opportunity to better understand this type of productivity.

                 

Margin and Profit-These metrics are the same for traditional bricks and mortar, catalog, and E-Commerce.

  1. Initial Markup Percentage (IMU%)-(Retail of an item-cost of an item divided by the retail of an item-($10-$4/$10=60%)). This is the mark up that buyers are most focused on when buying product and building an assortment. 60% might be a rough benchmark.
  2. Gross Margin Percentage (GM%)-This is the margin after discounts (merchandise markdowns + marketing discounts) ie the margin when something is sold. Sometimes referenced as maintain margin or final margin.
  3. Cost of Goods Sold (CGS)-This is exactly what is says which is nice. It is the inverse of Gross Margin. So in the example above $6 is the Gross Margin or Gross Profit then $4 is the inverse or cost of the goods.
  4. Operating Margin $/%-This generally refers to margin after all direct expenses of buying and selling the product have been taken into account. This would be GM% less any direct expenses such as advertising expenses.
  5. Earnings Before Interest, Tax, Depreciation and Amortization (EBITDA %)-This is the “bottom line” profitability of a business that many managers are rated on.  A Profit & Loss statement begins with Sales, subtracts cost of goods sold to get to Gross Margin and then subtracts S,G & A expenses such as staffing, warehouse etc  to get to EBITDA. I think many businesses would be happy with a 10% EBITDA as a very rough benchmark.

Inventory-These metrics are the same for traditional bricks and mortar, catalog, and E-Commerce.

  1. BOM and EOM-Beginning of month inventory usually stated in units if you are working with styles and stated in dollars if working at the product category level. End of month inventory is the same.
  2. Average Inventory-This is usually stated in dollars for a product category or a total company and is an annual metric. Add together the first month’s BOM plus 12 months of EOM’s and divide by 13.
  3. Turn-This is the rate you “turn” the inventory (like tables in a restaurant). Sales divided by average inventory. This should be apples to apples whether you are on a cost basis or retail basis. Ideally gross sales (net sales + markdowns) would be used but if you don’t have gross you can use net. This is also an annual metric and often compared across companies as a key metric. A benchmark for an apparel company might be a 4 turn.
  4.  WOS and DOS-Weeks of Supply and Days of Supply measures how much inventory is on hand at a given time, usually month end. Inventory divided average sales by day (usually the forecast going forward for internal mgmt purposes).
  5. Sales/Stock Ratio or Stock/Sales Ratio- This is simply as stated. I tend to utilize turn annually and then WOS and/or DOS by month at the category level.
  6. Sell Through Percentage-This metric is often used more at the item level than at total category level and is key in reacting to business. It is the sales divided by the original on hand. As an example we initially had 100 rice cookers and at the end of the first week we sold 15 which is a 15% sell through-not too bad. The second week we started with 85 and sold 10 which is a 12% sell through. At the end of the first month we sold 40 which is a 40% sell through and now we have 60 left. If something isn’t selling at 10% per week perhaps a markdown is needed or conversely if it’s selling 25% per week then maybe we should get a re-order assuming it’s not seasonal or no longer the fashion.
  7. Gross Margin Return on Investment (GMROI)- This is gross margin dollars (often for a year) divided by average inventory. This measure the marginal profit as a return of the inventory invested. A number like 350% or 3.5 is GMROI.

Now let’s shift gears a bit and talk about wholesale organizations:

Demand and Sales

  1. Demand-Demand measures the sales and potential sales for an item even if it’s out of stock and the customer did not get it. “Lost demand or true demand” is sometimes captured in the wholesale world but not consistently. My position is that this is crucial to know in planning for the future, maximizing sales and also for understanding customer satisfaction.
  2. Forecast Error (as opposed to forecast accuracy)-The most common metric is called MAPE (mean absolute percent error). It is the sum of the absolute errors (over forecast plus under forecast) divided by the sum of the actual and is stated as a %. This calculation is usually based on COGS (cost of goods sold). Depending on the business a 40% MAPE may be a good benchmark. While all organizations can continue to improve forecast error (or accuracy) what’s important is that an organization acknowledges that there will always be a fair amount of error (or inaccuracy) and that processes and contingencies are put in place to manage the results of the error (or inaccuracy) such as inventory excess and/or stock outs.  
  3. Fill Rate-This measures how much of the demand (or many cases customer orders) the organization is able to fill for the customer and is a key metric for management, sales, and customer satisfaction.  Depending on the business a 95% fill rate may be a good benchmark. Backorders are orders that may not be filled initially but filled somewhat late so it’s a good idea to state fill rate as initial (prior to backorders) and final (after backorders are filled) sales.
  4. Gross Sales-Generally means total sales dollars prior to returns and discounts.
  5. Returns-Dollar amount of goods returned-often stated as a % of Gross Sales. A benchmark might be a 10% rate.
  6. Discounts-Dollar amount of the discount a customer receives often stated as a % of Gross Sales. A benchmark might be 10% discount (which is different than 10% off depending  whether it’s stated as a % of gross or net sales)
  7. Net Sales -Gross Sales after returns and discounts. 

Productivity 

  1. Sales per Style-Gross sales divided by the number of styles. This gives a benchmark of what the average style produces and is a good metric to review in comparing departments and or when growing or shrinking a category. Often start up costs of an item are utilized to determine the breakeven point on sales of an item to determine when/if to develop new items.
  2. Average Order Size and Average Units per order- This is net sales(after discounts) divided by the number of orders. The larger the order size usually the more profitable since logistics costs then become a smaller %. Average Units per order tells you that the average order size of $150 is made up of 2.5 items per order. Often wholesale companies have minimum order size/units to insure profitability. 

Margin and Profit

  1. Initial Markup Percentage (IMU%)-(Sales of an item-cost of an item divided by the sales of an item-($10-$4/$10=60%)). This is the mark up that produce managers are most focused on when developing product and building an assortment. 60% might be a rough benchmark.
  2. Gross Margin Percentage (GM%)-This is the margin after discounts ie the margin when something is sold. Sometimes referenced as maintain margin or final margin.
  3. Cost of Goods Sold (COGS)-This is exactly what is says which is nice. It is the inverse of Gross Margin. So in the example above $6 is the Gross Margin or Gross Profit then $4 is the inverse or cost of the goods.
  4. Operating Margin $/%-This generally refers to margin after all direct expenses of buying and selling the product have been taken into account. This would be GM% less any direct expenses such as advertising expenses.
  5. Earnings Before Interest, Tax, Depreciation and Amortization (EBITDA %)-This is the “bottom line” profitability of a business that many managers are rated on.  A Profit & Loss statement begins with Sales, subtracts cost of goods sold to get to Gross Margin and then subtracts S,G & A expenses such as staffing, warehouse etc  to get to EBITDA. I think many businesses would be happy with a 10% EBITDA as a very rough benchmark.

Inventory

  1. WOS and DOS-Weeks of Supply and Days of Supply measures how much inventory is on hand at a given time, usually month end. This seems to be the most common metric in the wholesale world. Inventory (COGS) is divided by average sales by day (COGS). Finance and auditors most often refer to WOS/DOS looking backward because it has actually happened. Internal management must look forward and base WOS/DOS on a forecast since that is what they are managing inventory to. In a highly seasonal business this number fluctuates. Depending on the type of business 60 days of supply can be a good benchmark.  I like to always talk about the Yin and Yang of inventory management. If DOS are too low fill rate will be too low. If DOS is too high fill rate will probably be good (depends what the inventory is in) but excess DOS will be too high creating excess inventory-see below.
  2. Excess Inventory-Excess inventory is defined as the difference between the forecast for some determined number of days in the future (ie 90) and the amount of supply or inventory on hand (or in the pipeline).
  3. BOM and EOM-Beginning of month inventory usually stated in units if you are working with styles and stated in dollars if working at the product category level. End of month inventory is the same.
  4. Average Inventory-This is usually stated in dollars for a product category or a total company and is an annual metric. Add together the first month’s BOM plus 12 months of EOM’s and divide by 13.
  5.  Turn-This is the rate you “turn” the inventory (like tables in a restaurant). Sales (COGS) divided by average inventory (COGS). This is also an annual metric and often compared across companies as a key metric. Depending on the type of business a 5 time turn would be a good benchmark.