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Inventory management – it’s all about speed

warehouse copyIt is often said that the key to retail success is having the right product, at the right time, in the right place. Inventory is at the heart of what retailers do. It is your most significant investment and it is what generates sales. Success in retail requires robust inventory management practices and a deep understanding of how inventory decisions impact the bottom line. Simple inventory benchmarking techniques should form part of these practices for any retailer.

One of the most common measures of how well inventory is being managed is the inventory turnover ratio. This ratio tells you the number of times inventory is sold in a given period (usually a year). It is calculated as:

Inventory turnover (1)

This equation can be extended to show the average number of days it takes to sell inventory:

Inventory turnover (2)

Good inventory management isn’t just about how much is sold. What is important in retail is sales ‘velocity’. This means assessing your volume of sales by comparing it to the level of inventory you are holding to get a sense of the speed with which stock is moving through the business. This comparison should be made against internal and external benchmarks (e.g. competitors). While they produce very simple numbers, they can tell you a lot about how you are managing inventory and help you identify excess and aged stock, as well as shortages.

For instance, a relatively low inventory turnover ratio suggests too much unwanted stock, a lack of ‘freshness’ of product or general overstocking. This may be a sign of a lack of appropriate range planning and OTB (Open To Buy) systems.

Slow moving stock increases holding costs and often ultimately becomes obsolete, diminishing profits through write-downs. It can also tie up working capital and can give a false indicator of profitability because the gross margin achieved in the business does not take into account appropriate discounting to clear excess/obsolete stock holdings.

Conversely, a relatively high inventory turnover ratio may signal stock shortages. Make no mistake – out-of-stocks are just as big an issue as over-stocks. In fact, last year Forbes (Walmart’s Out Of Stock Problem: Only Half The Story?, April 2014) reported that Walmart was effectively forgoing $3 billion in sales each year as a result of stock shortages. Imagine the potential impact on gross margin and profit had these sales been achieved! Not surprisingly, stock shortages also don’t sit well with customers and can have a detrimental impact on satisfaction and loyalty.

There are a few things that retailers need to look out for when using these inventory benchmarking tools. Firstly, not all retail categories are equal. For example, An appropriate stock turn for a jeweller is likely to be unacceptably low for an apparel retailer.

Inventory turnover (3)

Secondly, seasonality also needs to be considered. Highly seasonal retailers that significantly increase their inventory holding in anticipation of peak demand periods will find that this has the effect of decreasing their inventory turnover ratio for that given period. For this reason, it is useful to calculate inventory turnover ratios on a rolling 12-month basis to remove the effects of seasonality.

Third, it is important to note that when conducting this analysis on a consolidated basis, the measure only provides an average of total inventory movements, and therefore can disguise trends in specific product lines and SKUs.

Accordingly, we suggest that, in addition to a consolidated analysis, inventory turnover is calculated on a category and even sub-category basis. This will assist with the identification of slow moving or high demand stock items, impacting inventory purchases as appropriate.

Finally, a significant amount of what retailers sell these days is imported from other parts of the globe. This means that, in addition to longer product lead times necessarily reducing stock turns (through higher inventory holdings), the reality is that correcting over or understocking issues identified as part of an inventory benchmarking process will take weeks, and possibly months, depending on your product lead times. This highlights the importance ofefficient and flexible inventory management practices.

What products are sitting on your shelf right now? How long have they been there? Are you regularly selling out of your most popular items?Inventory management should be front of mind for every retailer. Good inventory management results in better product availability, lower average inventory levels (freeing up your working capital) and increased profitability through reduced stock write-downs.

James Stewart is a partner and retail practice leader of Ferrier Hodgson and Azurium.

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