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By Bob Moorman, Senior
Business Analyst and Consultant
One
of the most confusing elements in merchandising is the
Open-to-Buy (OTB) process, meaning "how much money I should be
spending". Many buyers today in our industry are very good at
controlling their dollars; however, there are also many furniture
buyers that really do not have a clear point of view on inventory
allowance. Whatever your case, hopefully, you will find some
important considerations within this article.
The components
that comprise merchandising OTB Systems for a company are:
-
Turn Rate
-
Sales Forecasting
-
Gross Margin
-
Cost of Goods
-
Special Order Percent
-
On Hand
-
On Order
-
GMROI
The
actual Open to Buy process, in its purest form, is really the
investment strategy you have for your company, or if you are a buyer
within a company, then it would be the categories you are
responsible for buying. The term, investment strategy, is
always one that is not well understood in our industry. Investment
strategy means the way in which you select to run your company from
a dollar standpoint (TURN RATE), and how much money are you
willing to spend in order to get the results you want. When you buy
product, you build an inventory to have what the customer
wants, when they want to buy it. This is a simple enough
thought, or is it?
Let us take an
example and say your store is forecasted to do $3,500,000 in annual
sales.
If you are struggling answering these
questions, then you have a problem understanding the basic
fundamentals of an OTB process.
The
first component as mentioned above is turn rate. Until you
have ample historical data on which to base a turn rate goal, the
buyer should select a turn rate based on coverage. In other words,
how many months of supply do I need on hand to make my sales goal
for the retail store’s sales.
Most buyers will tell you that turn rate is the number of
times I turn my inventory in one year. This is absolutely correct
if you are looking at results. What I recommend is that you use
turn rate to engineer an outcome. You would do this by
selecting the turn rate on which to run your company and then
determine the product you are going to stock. There are other
considerations, of course, such as vendor lead times and the amount
of special order business.
EXAMPLE:
Sales
Forecast:
$3,500,000
GM % Goal:
47%
The
Cost of Goods is (100% - 47%) the other
53% or $1,855,000
Once this buyer has determined the amount of product they
are going to sell at retail, then they can determine how much
inventory they should have on hand on average. This is called
the optimum inventory level. Special order product does not
require inventory backup other than floor samples. Floor samples
should not be included in their inventory calculation if they
are tied down and not available for sale. However, if they
are available for sale now or in the future, then they need to be
included in the calculation.
Note, the
higher the inventory turn rate, the lower the
inventory allowance or months of supply.
|
Turn Rate |
Equity %
How much
inventory you have bought and paid for totally. |
Sales On Hand @
Landed Cost
Months of Supply
|
|
2 |
75% |
6 |
|
2.5 |
69% |
4.8 |
|
3 |
63% |
4 |
|
3.5 |
57% |
3.4 |
|
4 |
51% |
3 |
|
4.5 |
45% |
2.7 |
|
5 |
38% |
2.4 |
|
5.5 |
32% |
2.2 |
|
6 |
26% |
2 |
|
6.5 |
20% |
1.8 |
|
7 |
14% |
1.7 |
|
7.5 |
8% |
1.6 |
|
8 |
0% |
1.5 |
For
example: the $3,500,000 store has a GM% of 47% and a Cost of Goods
of 53% (or the COG = $1,855,000).
A turn rate is
selected based on vendor lead times and how many months of sales
they wanted on hand at cost.
Selected Turn
rate: 3.0 (4 months of sales on hand at cost)
Next,
they had to determine an optimum inventory level for their
company based on a selected turn rate.
Inventory
Level = $1,855,000 Cost of Goods
3.0 Turn rate
Optimum
Inventory level is $618,333
One
requirement of a buyer or owner is that an inventory “point of view”
must be understood. The investment strategy is based on turn rate
and must be followed by everyone involved in buying inventory.
Inventory pricing formulas and mix determines who you will be in the
market. Remember that inventory control is important; however I
still never discount the intuitive nature of buyers to develop a new
line or exploit an item they believe in. Remember to keep in mind
that inventory will always be your fastest depreciating asset.
If you have a
grasp on the above concept, it will become easier to understand the
month-to-month strategy of running a successful merchandising
strategy from a dollar investment.
In the
example of the $3,500,000 store above:
|
Sales Forecast: |
January |
February |
March |
April |
May |
June |
| |
$264,000 |
$321,000 |
$293,000 |
$255,000 |
$400,000 |
$380,000 |
|
Gross Margin %: |
47% |
47% |
47% |
47% |
47% |
47% |
| |
|
|
|
|
|
|
|
Cost of Goods |
$139,920 |
$170,130 |
$155,290 |
$135,150 |
$150,000 |
$140,000 |
(the
other 53%)
Selected turn rate: 3.0
Optimal Inventory Level
$ 600,490
Minus On
hands - 525,000
Minus On Orders
(store
inventory) - 50,000
Open
to Buy $ 25,490
There are many sophisticated operational systems that are in use;
however, they are rarely used effectively.
Many things must be taken into account when analyzing an OTB
worksheet or Point of Sale system reports. It is not just the
numbers we see; it is the other factors, such as the amount of old
product ownership you have on hand. If it is not “cleaned”
regularly, an overstock situation will be eminent.
You still have to buy back your number 1, 2 and 3 (best
seller) items, etc. Monitor (GMROI) Gross Margin Return on
Investment = Gross Margin $ Annualized divided by Inventory Level.
How much money are you making for every dollar you have invested?
As a guide, if your GMROI is below $2.00 it could be an indication
that your current assortment lineup may not be working. However, if
your GMROI goal is, let us say $4.00, then your conclusion may be
the same.
If
you don’t take your old inventory ownership into account, you
will be laying new inventory on top of old. The risk of not
measuring or tracking old inventory is that the amount of old
inventory could continue to grow unchecked forcing you into
higher inventory ownership. The
result could be higher inventory ownership without the sales to
support a good turn rate; it then becomes even more expensive to
operate the company with additional handling and more cash outlay.
Management of inventory and the dollars you use to
buy that inventory does require a strategy and considerable energy.
Blindly buying what you like without the consideration for turn
rate and cleanup of old product (product that has not had
an acceptable rate of sale over a specific period of time) is a sure
path to future hardship.
The most
successful companies in our industry understand turn rate,
sales forecasting, and gross margin goals. If you are
one of them, great! If not, now is the time to change!
“Why
suffer Results, When you can Engineer Outcomes”
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