Basics of managing Retail Business Performance

For any business, the top two performance measures are Sales and Profit. However Retailing is a unique business. A successful retailer has to hold a wide variety of products also known as SKU or stock keeping units typically running into thousands. This wide variety of SKU attracts a wide customer base.  Hence, it also becomes necessary to hold adequate stocks of these products at the stores and the warehouse. This inventory is responsible for 60% to 90% of a Retailer’s cost base – the rest being manpower cost, logistics expenses, rentals and utilities. Invariably, retail success is tied to the ability to convert this inventory into cash as quickly as possible while making profit – and repeating this process as many times in a year as is possible.

Carrying unnecessary or excess inventory can block precious cash and damage profitability. In addition, holding inventory for a long time results in shrinkage (loss of inventory due to obsolescence, theft, pilfering and damage) and other hidden costs viz moving the inventory, packing and unpacking costs, movement from stores to warehouse and vice versa. Hence, it is vital to ensure a very high level of Inventory productivity.

Retailers must use two metrics to understand their performance:

1)      Inventory Turns

2)      Gross Margin Returns on Inventory Investment (hereafter GMROI)

Inventory Turnover

Inventory turnover answers the fundamental question – how many times in a year am I able to turn my inventory into cash. Inventory Turnover links the average inventory and sales.

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Thus, if a Retailer holds Inventory worth $1000 (at retail sales price) and is able to sell the entire inventory once every three months, then the Inventory Turnover will be 4

GMROI

It is a measure of inventory productivity and expresses the relationship between total sales, gross margin and inventory investment. Stated very simply, GMROI calculates the total return for every dollar invested in inventory. As a rule of thumb, GMROI should be a minimum of 1.2. This means that for every dollar invested in inventory, 1.2 dollars is the return expected – of which one dollar can be reinvested in inventory while the remaining 0.2 dollars is for all the overheads

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How to use GMROI and Inventory Turnover?

By comparing GMROI and Inventory Turns, it is possible to identify high performing products from poorly performing products.  Using these two metrics, steps to improve performance can be identified. The same is illustrated using an example below

Product Annual Sales (Dollars) Gross Margin (%) Average Inventory Cost

1

40000 42% 17000

2

35000 47% 11500

3

18500 49% 7500

4

18000 35% 3900

5

27500 44% 10000

Now, if we give importance only to Annual Sales or Gross Margin%, we will focus our attention to product 1 or product 3. On calculating Inventory Turns and GMROI, we can update the table as shown below:

Product Annual Sales (Dollars) Gross Margin (%) Average Inventory Cost Inventory Turnover GMROI

1

40000 42% 17000 2.35 0.99

2

35000 47% 11500 3.04 1.43

3

18500 49% 7500 2.47 1.21

4

18000 35% 3900 4.61 1.61

5

27500 44% 10000 2.75 1.21

On using the right metric (GMROI and Inventory Turnover), we find that product 4 is the best performer by a mile. Product 2 is the second best performer on GMROI. Strategy for these two products should be to meet or exceed the performance already achieved.

Product 1 with highest sales has GMROI less than 1. This effectively means it is not meeting minimum performance requirements. The reason could be markdowns and discounts used to achieve high sales have eroded profitability.

Between Product 3 and Product 5, there is not much to choose from as both have the same GMROI. However Product 3 has a higher Gross Margin% . Thus, the next step should be to reduce the Gross Margin and see the impact on Inventory Turnover and Sales for Product 3. It is quite possible that Product 3 is priced higher and lower prices may enhance consumption.

Thus using Inventory Turns and GMROI, retailers can assess their performance. The beauty of these KPI is that they can be aggregated as well. For e.g., retailers often assess their overall performance and then drill down to the performance of a department or category, merchandise class, product sub group and eventually the product. Similarly, it is possible to calculate these KPI for store / vendor / cluster of stores allowing a like-for-like comparison. It is possible to compare various types of Retailers based on Inventory Turns and GMROI. Based on the type of products / store / buying-selling strategy, there could be multiple types of Retailers viz Bookstores, groceries, supermarkets etc. Based on a study by North American Retailers Association, the Inventory turns and GMROI for a type of Retailer tend to be within a cluster.

Retail KPI Averages in North America

For North American retailers, the average Inventory Turns and GMROI are shown in the table below

Retailer type

Inventory Turns

GMROI

Supermarkets / Groceries Store

15.2

3.86

Fruits/Vegetables Stores & Markets

40.5

5.27

Convenience Stores

27.3

5.19

Pharmacies / Drug Stores

11.9

3.0

Furniture

3.6

1.53

Hardware Stores

2.7

0.98

Home Furnishings

3.2

1.38

Cosmetics Stores

3.1

1.33

Specialty Retail Stores

2.7

1.24

Florists

10.2

5.35

Apparel

3.5

1.88

Consumer Electronics Stores

6

2.16

Benchmarks available on Retail Owners Institute® (www.retailowner.com) All figures for 2009

Fruits and Vegetable stores have extremely high Inventory turns and very low Gross Margin. Typically, the replenishment cycle ranges from once a week to even twice or thrice a week. However their Gross Margins are very low and they have extremely high rates of shrinkage/damage. On the other hand, specialty stores work with extremely high Gross Margins and low turnover rates because of the special nature of their products. Hardware stores have low inventory turns due to the poor state of US construction industry in 2009

Retailers can use GMROI and Inventory turns to maximize their business performance. An analysis similar to what we have done is a must to drive business growth

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2 thoughts on “Basics of managing Retail Business Performance

  1. Pingback: Retail Store Performance – Managing Space | apply thinking

  2. Pingback: 5 best retail math articles from Summer 2012 | Three Buckets Blogging

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