Tag Archives: Applied Thinking

Interpreting Turn Numbers – Part 2

In a previous post I discussed the reasons why a larger turn number is not always considered agrocery-store-2119702_640 healthier turn number.  The first reason involved negative profit margins.  The second reason was high out of stocks.

There is a close relationship between turnover and inventory levels.  Turnover is essentially a measure of how efficiently a retailer is utilizing their inventory in creating sales.  Looking at the turnover equation (Annual Sales/Average Inventory – see Inventory Turnover:  Retail, Cost, or Unit?), it is easy to see that there are only two ways for a retailer to improve their turn numbers.  They can increase sales or lower inventory.  For now, let’s concentrate on the latter.

Smart merchants spend a great deal of time studying their category’s in-stock (aka on-shelf availability) levels.  These numbers tell the retailer whether any particular product is in inventory.  When an item is 95% in-stock, the retailer may assume that 95% of the time that product was in the store and available for the customer to purchase.

Retailers typically lower their inventory levels (and improve their turn numbers) in healthy ways, by cutting excess inventory or dropping SKU’s for which there is little demand.  These changes should not impact the products in-stock levels.

However, when a product’s both a product’s inventory level and in-stock level drops, this is a bigger concern.  This means that for whatever reason – the retailer is not able to keep enough inventory on hand to satisfy customer demand.  In other words, products are not being replaced when they sell out.

The resulting increase in turnover rate is considered unhealthy for two reasons:

  1. If the product had been in-stock, customers could have purchased it and sales would have been higher.
  2. If customers wanted the product but couldn’t find it, they may have decided to purchase it at the competition instead.

 

Interpreting Turn Numbers

No Retail Math number is useful unless you are able to interpret it, 24607796422_e5979e3304_q
and this is just as true for inventory turnover rates as it is for sales or profit figures.

In general, retailers prefer high inventory turnover numbers.  The higher the inventory turnover, the more times the retailer has sold their average inventory.  This means that a higher turnover rate normally correlates with higher levels of sales and profits.

Let’s Calculate!
Retailer #1 carries an average retail inventory of $300,000 and has annual sales of $900,000.  This gives them an inventory turnover of 3.0 ($900,000/$300,000).  If Retailer #1 has no markdowns and a maintain margin of 10%, then they will achieve a profit of $90,000 ($900,000 * 10%).

Retailer #2 carries the same average retail inventory of $300,000, but manage their inventory more efficiently, turning it 4.0 times that year.  This gives Retailer B annual sales of $1,200,000 ($300,000 * 4.0).   If they also have no markdowns and a maintain margin of 10%, they will earn an annual profit of $120,000 ($1,200,000 * 10%).

Is it always true that a bigger turn number is better?  While retailers do generally prefer that their inventory turnover rates increase, there are 2 exceptions to this rule.

The first is when dealing with a loss leader.  If a retailer has a negative initial margin for a particular item, then they may not wish to drive their turnover numbers higher.

The second is when the retailer’s out of stock levels are high.  This situation is one which will be covered in a future post.

photo credit: danielfoster437 <a href=”http://www.flickr.com/photos/17423713@N03/24607796422″>Fresh Produce</a> via <a href=”http://photopin.com”>photopin</a> <a href=”https://creativecommons.org/licenses/by-nc-sa/2.0/”>(license)</a>

Gross Profit vs. Gross Margin vs. Gross Profit Margin

meadow-680607_640Some time ago Mame asked me the difference between gross profit and gross margin. As this is a question that crops up regularly in my classes, I thought it might be a good idea to tackle it here.

The truth is, there really isn’t a difference. Some retailers prefer to say gross margin, other retailers prefer to say gross profit. (Although some will use the term gross margin when referring to gross profit as a percentage of net sales.) Both terms refer to the difference between net sales and total cost of goods sold.

Much like the term gross margin, a few use gross profit margin to refer to gross profit dollars as a percentage of sales.

Measuring & Analyzing Sales

Sales are the lifeblood of retail.  Perhaps that is why we have so many different ways to measure, report and analyze sales.  I thought I would use today’s post to do a brief rundown of some of the different types of sales measurements that are used by retailers.  (Please note that because I am a marketer – I am not looking at these from the perspective of an accountant, rather I’m coming at them from the perspective of a merchant or a buyer.)

  • Gross sales– all sales on all merchandise and services during the given time period.  This one is the grand-daddy of all sales measures, since it is the only one to include everything.  Gross sales is an important measure because of its ease of comparability across different retailers.
    Formula = Average price * units sold
  • Net sales– gross sales less returns and allowances.
    Formula = Gross sales – (returns + allowances)
  • Overall sales– a retailer’s total sales.  Typically reported in percentage form.  Overall sales are used to measure a retailer’s growth.
    Formula = (TY Sales – LY Sales)/LY Sales  (Note:  for overall sales, include all sales from all stores.)
  • Comparable sales– also known as same store sales, are a measure of sales for all stores that have been open at least one year.
    Formula = (TY Sales – LY Sales)/LY Sales  (Note:  only include sales from stores open at least 12 months.)
  • Sales per square foot– average amount of sales generated per square foot of selling space in the retailer’s stores.  Sales per square foot is a popular measurement for determining how efficiently the retailer is using their sales space.  According to RetailSails.com, Apple has the highest sales per square foot of any U.S. retailer at $6,123.  If you would like more information concerning U.S. retailers performance in this area, check out RetailSails.com’s chart for all retailers or their listing for the grocery industry(Update 9/19:  RetailSails.com’s website is temporarily down.  Some of the same information can be found in an April post by ASYMCO.)
    Formula = Sales/Total square ft. selling space
  • Stock-sales ratio– the ratio between the amount of inventory (stock) you have available and the amount you are making in sales.  This measurement helps retailers determine if they are carrying too much or too little inventory.  If you would like to learn more about how to interpret this ratio, I recommend Rick Segal’s analysis at The Retailer’s Advantage.  And, if you would like some ratios to compare your numbers to, the U.S. Census releases reports for U.S. manufacturing and sales inventories/sales ratios every month.  (http://www.census.gov/mtis/)
    Formula = Beginning of month inventory/Sales for the month
  • Online sales ratio – the ratio between a retailer’s online sales and their total sales.  The online sales ratio was developed by Investopedia.  It is further explained in their article “Online Sales Ratio Key to Retail Success”.
    Formula = Online sales/total sales
  • Sales per transaction – this ratio can be calculated in either units or dollars.  Many retailers choose to calculate and track both.
    Formula = Sales/# of transactions

There are many more sales measurements than those listed.  For example, many retailers calculate sales per linear foot of shelf space, sales per department, sales per hour, or even sales per labor hour.  All are good measurements for determining base efficiency levels and the health of a retailer’s sales.  If you have a favorite that I haven’t mentioned, please let me know about it.

 

Orbitz, Pricing, & Average Initial Margin (Part I)

Several articles were written last month concerning Orbitz’s methods of targeting Mac users.  A post on the HBR Blog Network by Rafi Muhammed (Should Internet Retailers Discriminate Between Customers?, July 10, 2012) stated:

“So if online retailers can identify customers with different price sensitivities, why not charge different prices by customer type? After all, this is commonly done in the brick and mortar world. Retailers often set different prices in different locations. Target has acknowledged using this practice based on the level of competition at each location: If many rivals are close by, prices are lower, but if it’s the only game in town, prices are higher. Gas stations routinely charge different prices at different locations. Similarly, it’s customary to negotiate for certain types of products and services, so the price that anyone pays for, say, a car will vary based on product knowledge and negotiating skill.”

Muhammed goes on to debate the wisdom and ethics of such behavior, and I highly recommend reading his entire post.  (As Muhammed points out, brick and mortar retailers have long done this in the form of zone pricing.)

From a financial standpoint, what we’re really looking at is the impact on average initial margin (average initial markup) of having 1 cost and 2 (or more) retails.  Thinking through this potential pricing scheme, I decided to run a few numbers, and I’ll be posting those numbers in a couple of days.  If you have suggestions for other numbers or ratios to look at – I’d love to hear them.

Topshop Brings Fast Fashion to Nordstrom

The idea of combining fast fashion with traditional department stores has intrigued me ever since JCPenney went into partnership with Mango few years ago.  I can’t help but be fascinated by the concept of fashion clothing that is meant to be frequently replaced by consumers, and therefore must be updated weekly in stores (just think of the supply chain implications, not to mention the labor involved in changing a sales floor weekly.)  Bringing this high-turnover merchandising concept to stores known for carrying high margin/low turn merchandise is, well, fascinating.

It seems that the latest duet to try this concept is Nordstrom and Topshop, and this particular combination looks like a winner to me.  Whether it will be successful in the long run is always a matter of debate, but it’s an interesting concept from a three bucket perspective.  After all, Nordstrom is gaining not only the Topshop brand image, but also a fashion oriented product with a high turn rate (and great asset efficiency.)  On Topshop’s side of the table, they gain a large increase in distribution and an accompanying increase in volume.  (Sources:  Nordstrom Dresses British With Topshop to Win Back Women: RetailTopshop is Coming to Nordstrom)

Speaking of interesting partnerships, I’ve been reading several articles about how Neiman Marcus and Target are teaming up to create a limited edition of holiday merchandise (designed by top names such as Oscar de la Renta and Tory Burch) to be sold in both of their stores this coming December.  The partnership even has its own logo – an exclamation point with a Target’s bulls eye as the dot.  I understand what Target is getting out of this, but can anyone explain to me the benefit to Neiman Marcus???  (Sources:  Neiman Marcus and Target join forces to create holiday gifts; Retail’s New Odd Couple)