The Power of Incremental Gains in Inventory Planning
It's a given that inventory planners are always wrong. I learned this lesson early in my inventory planning career at Lands’ End many years ago. It was understood by the inventory staff that there would be mention at the end-of-year company meeting that inventory negatively affected results. The message was either, "demand was great, unfortunately, we were unable to capture all the sales due to shortage of inventory" or "sales were good, but unfortunately, gross margin suffered due to markdowns to liquidate excess inventory."
It seemed impossible to a young inventory planner to ever get it right. Turns out, as I gained a few more years of experience with companies like Duluth Trading, Nordstrom and, more recently, working with Direct Tech's and SPI's customers, I learned it truly is not possible to ever have perfect inventory. Success is measured in the balance of good vs. problem inventory and progress is measured in small increments.
Yet, those small increments deliver important benefits. Given inventory's direct impact on a company's key financial metrics — sales, gross margin, profit and cash flow — very small improvements in key inventory performance will deliver significant financial gains.
The table below represents the financial returns a $50 million retailer can achieve over a five-year period with very modest gains in inventory metrics. With the small improvements described below in a few key inventory metrics, the cumulative benefit over five years is more than $2 million in pre-tax profits and more than $1 million in cash flow gains.
The assumptions used in the table are as follows:
- Sales: base of $50 million, with 5 percent annual growth.
- Gross margin: base of 50 percent, with sustained improvement of 0.25 percent, which is roughly equivalent to reducing the percentage of markdown inventory by 1 percent of total inventory.
- Final fulfillment vs. potential sales: base of 95 percent, with sustained improvement of one percentage point to 96 percent.
- Backorder rate: base of 4 percent of potential sales, with sustained improvement of one percentage point to 3 percent.
- Inventory turnover: base of 3.5 turns, improving by 0.10 turns per year to achieve four turns in year five (assuming 10 percent valuation of inventory carrying costs).
- Operating expense: 20 percent of each incremental sale.
So inventory planners, take heart. You don't have to deliver perfect inventory to deliver success. You can make a real difference for your business simply by putting the processes and systems in place to deliver sustained incremental gains.
Joe is Vice President of Product Solutions at Software Paradigms International (SPI), an award-winning provider of technology solutions, including merchandise planning applications, mobile applications, eCommerce development and hosting and integration services, to retailers for more than 20 years.
Joe is a 34-year veteran of the retail industry with hands-on experience in marketing, merchandising, inventory management and business development at multichannel retail companies including Lands’ End, LifeSketch.com, Nordstrom.com and Duluth Trading Company. At SPI, Joe uses his experience to help customers and prospects understand how to improve sales and profits through applying industry best practices in merchandise planning and inventory management systems and processes.