Specialty Retail Blog

Retailers may have some very helpful allies in places they would least expect to find them.

This article seeks to highlight some useful, but typically ignored synergies between science, engineering, business and retail. Karl Popper elegantly described the purpose of science as a process which generates predictive theories.  Science, economics and all kinds of business applications rest critically upon a common need; the need to accurately forecast a complex and dynamic future.

While the goals of science, economics and business are worlds apart, the actual process of forecasting is common to each. Similar challenges in forcasting allow lessons learned in one discipline to be applied in another.

Here, we’ll look at what forecasting insights can be gleaned from raindrops and market drops to help make our retail profits a little more stratospheric.

The most basic, even instinctive, method of forecasting involves guessing what will happen. Humans naturally learn to link certain events together. A midwestern corn farmer might say “knee high by the fourth of July.” If the crop isn’t tall enough by the given date, the farmer knows in advance that the crop has gotten a bad start and will therefore yield a weak harvest. Other times, the process is more intuitive, what we call “gut instinct.’ A person might “have a bad feeling” about some situation, even if he’s unable to explain the rationale behind it to another person. Recognizing patterns is something people do without even trying. It’s nearly impossible to look at a word written on a page, for instance, and not “read” it.

Of course, this kind of guessing is one of all kinds of human flaws and limitations. It lacks the dispassionate rigor of an actual scientific experiment. Just knowing that the crop isn’t high enough tells a person nothing about what caused its short stature. Even worse, it offers no clues to fix the problem. Gut instinct is difficult to transfer from one person to another. It creates dependence on a person, rather than a process and it’s horribly subject to the constraints of a single person’s memory and intellect. Using only gut instinct is better than nothing, but even at it’s best it is imprecise and prone to error. Stock outs sometimes and markdowns others is the result.

Of course, some of these problems can be solved by using past trends and performance to predict future results.

This approach is a little more precise and predictive if the system varies the same way it has done in the past. We’re no longer relying on the feelings of one individual and emotions are checked somewhat by stubborn little numbers. But it’s still less than ideal.

The professionals that spoke on climate research at a talk I attended recently amazingly faced the same problems that we faced in trying to predict future sales and performance for retailers. They started, as we did, using statistics.  Statistics and trends are useful in a somewhat stable or controlled environment. In statistical terms its changes can be depicted by a bell shaped curve or some other known distribution.   When climate change was affected by increasing CO2 the statistics based on the past could no longer predict the future.  Retail , also, is a constantly changing environment. When the recession hit, trends based on past performance were completely invalid.

The solution the climatologists brought to bear to help understand our dynamically changing environment was to make mathematical models of how the system worked. Over the years the model for climate change was modified to include surface temperatures, then atmospheric makeup including CO2, methane, and other gasses. Moisture content, then ocean temperatures were added. Then solar radiation coming in and out was added and so on. As each new variable was added to the model, a more accurate prediction was possible.  The true test was to back test to see if the model predicted what happened in the past. The final test is to see how accurately it predicts what happens in our actual, uncertain future.

We went through similar trials and tribulations to develop our Winning@Retail™ software. It contains both analysis of past performance using statistics and mathematical models  that account for the effects of the economy, local buying habits, inventory levels and much more to get an accurate prediction of future sales.  With each new variable added to the model the predictions improved.  Several independent tests have measured our ability to predict sales at 94% or better.

Just as knowing the future of climate change can help us prepare for the coming challenges, knowing future sales allows us to identify the right inventory levels and predict cash flow in the business.  If we don’t like the outcome, we can use the models to chart a new course based on a solid forecast of coming trends. Rather than just seeing a bad crop coming several months ahead of the harvest, we can consider how to nourish a business so that it continues to be fruitful and productive. The use of predictive models is the best approach to inventory planning.  POS systems and many spreadsheet approaches use statistics to project the past into the future.  Their susceptibility to sudden shocks and changes causes waste, errors and inefficiency, often when they are most painful.  The better your data and analysis, the better the predictions and the better the results will be.

I was amazed while reading some statistics that 63% of Americans are concerned about the swine flu but  over 60% say they haven’t received the vaccine and do not plan to get it(ABC NEWS POLL).   That means 23 % of the Americans are worried about their health being jeopardized by a pandemic disease yet they don’t plan to be bothered to get a vaccine that costs $18 to prevent that disease.  Another 37% are not concerned about a disease that the best and brightest scientists have identified as a potential pandemic and threat to a significant number of Americans (according the CDC, to date 50 million Americans have contracted the swine flu virus and nearly 10,000 have died).

Since we deal with independent retailers, I obviously thought about the huge implications that statistic has for those retailers to whom we provide merchandise planning and OTB budgets for each month. Understanding this new retail environment is truly an enigma wrapped in a conundrum as Dennis Levine, one of our affiliates would say.  The statistics above prove that point.

The big challenge a retailer faces every season is finding the right lines and items that their customers will be motivated to buy.  If 20% of the people are not motivated to spend $18 on their own health and well being even if they believe it could be in jeopardy, and another 40% are not motivated by what many would argue are the obvious facts, the ability  to motivate customers  to buy the merchandise they pick  is an enormous task.  Fortunately the buyer usually has some great sales people to close the deal but that hardly absolves the buyer of significant responsibility for success.

The research that a buyer must do to accurately and profitably invest the company’s funds and make a profit is daunting. The two aspects of knowledge with which every buyer must enter the market are what will the customer buy and how much will he buy. Even the government only needed to predict demand in ordering flu vaccines!

Merchandise planning always begins with accurate forecasts of demand for each classification of merchandise in the store. Sales will happen when that demand is met with desirable merchandise and an effective sales force.  Once you know the demand (or, with the government example, how many people will want the flu shot) you can then determine how much inventory you have, how much of it is effective, how much additional inventory  you will need and what you can spend on it.  That gives your OTB budget.

The buyer must then be adept at assortment planning. This is where a good POS system can help document the lines, sku’s , colors and fashions that have been selling.  Just like your stock broker tells you, “Past performance is not necessarily an indicator of future sales!”,  a good buyer must be on top of the market, fashions and trends. That means hanging out where your customers hang out and watching what people are wearing.  Predicting the next trend is always a gamble but understanding your customers taste levels is a necessity.

I guess a buyer that gets the best merchandise planning along with OTB information and does the best trend analysis and assortment planning should be able to satisfy as much as 40% of his market. After all, that is the portion of the market that is motivated to get a simple shot to prevent a life threatening disease from attacking his body. That really makes it clear how little room retailers have for error in the current retail market and how important getting the right information on which to base decisions will be.

A good article on optimizing turnover rates by M1 Affiliate Alan Roseman

Retailers are entering the fourth quarter with many significant and important questions. The way they respond to these inquiries and respond to the circumstances will dictate their success. Three of the most fundamental questions I see are:

1. What will traffic be in the store?
2. What will sales be?
3. What will margins be?

Let’s apply some logic to see if we can find some likely answers. Many people have lost their jobs (~10%) and even more are underemployed (~17%) which means they are making less money than they did a year ago. All these people will not be taking vacations or spending a lot of money on entertainment like they did before. We are talking about one out of six people; the losses cut across all income brackets from laborers up to executives.

Even with lower credit card limits, tighter credit and less home equity as financial supports, for the most part, these people will not ignore the holidays and will be shopping for gifts. The probability is that they will be looking for less expensive items and bargains this year in addition to the special gifts they buy at regular prices. The best news is there is a form of entertainment that they can still afford and that is shopping. Look for the store traffic to increase this holiday season which is good news for retailers. Keep in mind that now, more than ever before, the more entertaining you are, the more traffic will be searching you out.

Those who have less discretionary income are joined by many others in worrying about what lies ahead. On the positive side, the stock market has run up nicely to about where it was at the beginning of the year. That has released some pent up demand among the 73% of the population who are fully employed. That means there will be a demand for full price goods but also a pull for discount, off price and lower price point goods as well. Balancing the inventory mix will be tricky. No one knows when discounting will begin and how brutal it will be. That means this season your inventory planning, balance and flow is as critical as enhanced selling skills will be to determine your success. With traffic up, conversion rates could be the main dashboard components on which to focus!
Margins are the big unknown this year. It is a question mark whether the chains will pull the trigger on markdowns early again or whether they took a big enough beating themselves last year to buy more prudently and be able to hold the line on discounts. We have been working hard to find ways for clients to boost margins in the face of uncertainty and the moves are working. Certainly the Margin Buying Service is a great key for women’s boutiques to boost IMU to 70% and increase turns at the same time. The holiday suit promotion was a similar opportunity for men’s. More prudent markdown strategies are needed this year to keep up the MMU. There are opportunities out there but retailers must be aggressive to grab them.

There are a lot of other situations and circumstances that will affect retailers – from the scarcity of certain goods to a scarcity of credit available to buy them – but these three stand out as critical. The unknown factor is again extremely significant this year so be adaptable, flexible and keep listening to your market and to your affiliate. These will be the keys to your success.

Happy holidays and good luck!

“Turn turn turn, see whats become of me” was prophetically written by Simon and Garfunkel over 40 years ago.  I am not sure if they were thinking of retail at the time but truer words could not be sung.  Retail is based on buying goods and then selling them for more than you paid for them.  If you only do that one time you do not make much cash.  The more times you can sell your inventory, the more cash you make.  Every time you sell your inventory you have “turned” it one time.  The more times you turn your inventory, the more cash you put in your coffers.  Turn turn turn and see what will become of YOU!

Turn is the relationship between inventory and sales and determines the success a retailer has in generating cash.   Just like any measurement, to be useful the measurement must be applied at the right place to have meaning.  Although a general indicator of a store’s success can be indicated by overall turn, a much more useful application of turn occurs at the classification level.  Every class should have a targeted turn based on the store’s location and character, the type of inventory (staple, fashion, hard goods etc. ), the season and many other variables that are all part of an effective merchandise plan.  When a classification is turning too fast, it could likely indicate that sales are being lost due to lack of selection, sizes or depth. If a classification is turning too slowly, there is too much inventory due to overbuying, old goods or other reasons that are taking up cash, space and focus while not generating sales.  Unless you have the right target, you don’t know what is too fast or too slow!

The Formula

Turnover is calculated over a continual 12 month period of time.  It is 12 months of retail sales divided by the average retail inventory over a 12 month period.  A good estimate of  turn rate can be calculated by  taking the first of month inventory amount for 12 consecutive months plus the ending inventory at the end of the 12^th month and dividing this number by 13.  This will yield the average inventory amount.  Now divide the total sales for the same 12 month period by the average inventory amount to get the annual inventory turnover rate. In a seasonal business, annual turn is the best way to analyze turn.  We  also do a 12 month rolling average turn to get the most recent data but still including a year’s worth of data.

Why is Turnover rate Important?

The questions that a calculation of turn answers is whether you would like surplus inventory sitting on your racks or more cash in your bank account.  Too much inventory on the racks, ties up cash, yet not enough inventory results in lost sales.  Turn is the relationship between the inventory and the sales and when done at the class level, helps you find the right balance for your store.   Since turn generates cash, your challenge is to increase sales without increasing inventory. That is the goal of the science of merchandise planning! The secret lies within the art of sales forecasting for each classification. The skill lies in arriving at the right target turn rate for each classification in each store.  The results come from adhering to the right plan.

Simon and Garfunkel got it right. Turn is the key to your success.  Focus on it. Manage it. Plan for it. See what will become of you.

How do you eat an elephant?   You don’t want to choke on too much inventory, or for that matter too little inventory. So as you know, you eat an elephant one bite at a time.  The same goes for your business. Looking at your business can be like looking at an elephant; too big to take on and control.

When you break down your inventory into bite size pieces all of a sudden it begins to make more sense. We call those pieces classifications. By breaking a store down into classifications it is easier to determine what is selling and what is not, it is easier to buy goods and know when to mark them down. Classifications tell us a lot of things about our business one bite at a time.

The single most important reason to maintain a good classification structure is simple. Customers buy by class. Period. A shopper comes in your store and they are thinking about purchasing a board short, or a swimsuit, or a tee. They might want a Hurley, or a Bill a Bong, or a Volcom, but their first motivation is the class. That is one of the reasons why buyers look at class first and then develop their assortment by vendor.

Trends evolve around classifications. Tees, novelty tees, graphic tees, board shorts, dresses, sport shoes, sandals, etc. Each of these has its own ebb and flow. What is the demand for each classification? Let’s say you want to cut your receiving budget by 20% because you believe your sales will be down by 20% for the next period. Sweeping cuts like that can kill a business. Some classes where demand is thin may need to cut by 50%; other classes where demand is strong may need to be increased by 25 to 30 %. If you cut emerging and growing classes you will call serious harm to your business.

Another way to look at it is that being under stocked in key classes forces your customers to your competition.  You have heard the expression “to have what the customer wants when they want it and at the right price is the key to successful retailing.” That all starts with an effective and manageable class structure.

Manageability is key; too many classifications is impossible to keep up and too few diminishes your ability to read demand. For example Men’s sportswear is too broad a category to plan. It is composed of tees, pants, shorts, board shorts, woven’s, knits, etc. Every one of those classes has its own life span and profit center. If you only had a budget for sportswear, then what would be the best way to allocate those dollars? Furthermore each one of those categories has its own initial markup, its own markdowns and its own turn rate.

Too many classifications are difficult to manage and you spend more time micro-managing your business than taking the time to look down from a higher level.

These are a few highlights of why classifications are the underpinning of any retail business. Review your classifications and make sure they make sense for you and your customers.

When reviewing your financial statement there are several key elements that determine profit:

1. Net sales- the amount of sales during the reporting period. This amount reflects the total value of merchandise sold to your customers. Markdowns are subtracted and sales tax is not included in Net Sales. Some other caveats to remember is that gains or losses from investments or from charging customers for alterations are not included in Net Sales. This income is added below as Other Income. Also, Net Sales assume an accrual basis for accounting. For example, if an item is sold on a house charge that item is included in Net Sales even though the revenue has not been fully collected. Should the monies never be collected then that becomes an expense when it is determined uncollectable.
2. Cost of Goods Sold- this is sometimes referred to as Cost of Sales. Cost of Goods Sold is what it actually costs a retailer for the goods that he sold during a given period. The correct formula for determining Cost of Goods Sold for merchandise is:a.Beginning inventory at cost
   b.+Purchases at cost
   c.-Ending inventory at cost
   d.=Cost of good sold

   Accountants will also include freight-in, as Generally Accepted Accounting Principles requires that this expense directly related to bringing the merchandise available to sell be included. Cash discounts are often also reflected as a separate line item in the Cost of Goods section of the financial statement as a reduction in purchases. This is particularly true for retailers who include discounts when determining initial mark up. Generally Accepted Accounting Principles for publicly held companies requires that they be reflected as a credit expense or other income as a line item on the income statement. In smaller companies cash discounts and incentives are immaterial and their placement on the financial statement is at the discretion of the owner. It is important that whatever is included be consistent over time.

3. Gross Profit- Net Sales minus Cost of Goods Sold. This is the money that is available to pay other expenses, bills, salaries, taxes and profits.
4. Total Operating expenses- A list of all your expenses- occupancy, salaries, selling, general and administrative expenses. A dividend or distribution that the owner takes is not included in operating expenses.
5. Net Profit/(Loss)- Gross Profit minus operating expenses. This is what is available for dividends, debt reduction, or dollars to reinvest in the business.
   Inventory ValuationCut off procedures for purchases to collect all receiving within a given period

   Omission of purchases awaiting invoices from vendors

   Returns of merchandise to vendors or from customers not recorded or included.

   Net sales not recorded due to different procedures like lay-a-way and special orders.

   Unrecorded transactions for transfers of merchandise

   Unrecorded invoices for merchandise

   Overages, Shortages, or theft unrecorded

   Promotional sales not recorded when sold

   Gift certificates, payments in advance, or credit not posted or not recorded correctly.

   Damaged merchandise not reflected

   Sales tax included inaccurately.

Sometimes financial statements will calculate Cost of Goods Sold strictly as purchases for the period. It is not quite that simple. Cost of Goods Sold is based on goods available for sale during the period that is being reported. Goods available for sale includes beginning inventory as well as merchandise purchased during the period reviewed. Simply stating purchases instead of an accurate Cost of Goods Sold calculation does not take into account beginning and ending inventory. For example, merchandise theft impacts profits by raising Cost of Goods Sold. The merchant pays for goods whether they are stolen or given away. This is reflected in the difference of beginning and ending inventory and the accurate reflection of these transactions would boost the Costs of Goods Sold. Showing only purchases as Cost of Goods Sold distorts the profit and would result in decisions, like income taxes to pay on a less accurate measurement.

How inventory is valued with the different acceptable methods, like LIFO, FIFO, or Average Cost can have a direct impact on your financial statement. (We will examine this in greater detail in our November issue)

The accuracy of your financial statement’s Cost of Goods Sold should be gauged each time you review it by examining the related percentages in comparison to prior periods and your knowledge and experience. Reflecting Cost of Goods Sold accurately on a financial statement is critical to its overall accuracy.

The first litmus test on the accuracy of a financial statement is the Cost of Goods Sold. Its accuracy provides the level of confidence in the exactness of the overall bottom line.
Here is a short list that can go wrong:

This November we will be taking a look at inventory valuation in greater detail. The timing of this information comes at a critical time in management’s decisions to use correct valuation decisions for year-end statements that could benefit tax situations.

It has been estimated that up to 30% of retailers won’t make it through this recession in business. Almost every one of those failing retailers will have one characteristic in common. Prior to going out of business they will cut expenses. Some will cut more and faster than others but most, if not all of them, will cut expenses.

(more…)

Yesterday is gone.

How long has it been that you have had “change” thrown at you? (And I don’t mean coins). Now you realize, ‘I either change, or my business is one for the history books’. Change what? Change how? Is it too late? Is it worth the struggle?

This is a time of opportunity! Great change brings on new hope. Rules are being re- written and everyone has an opportunity for a fresh start. As you watch your competition melt away, your suppliers have become more flexible. Your creditors, landlords, and most of your other providers are demonstrating a willingness to change their rules. Contracts are being re-written, debts are being renegotiated and for many small businesses this can be one of a second chance. The doors around you are opening in a way you could never have imagined.

Can you seize this moment in history?

Consumers have not stopped spending; they may be looking for better deals and more value. When the economy bounces back, customer loyalty to those retailers that have responded will clearly remain intact.

Let’s address the elephant sitting in the room. What is the willingness of the consumer to spend? What is their ability to spend? These are significant issues as they are the crux of forecasting demand.

As demand diminishes so do prices. In step, supplies will also decrease until there is some equilibrium. Appropriate strategies need to be addressed and put in place and measured, as changes are occurring rapidly. For example; Coach, a luxury maker and retailer of expensive handbags, has identified that the right price to increase demand for their products is $300. Coach is one of 20 successful retailers that are doing well in the current economy. Yes a luxury retailer! They have responded and found the price where they can generate demand.

One strategy is to break key classes into price points. Some of our retailers have already addressed this issue. Denim, Woven’s, Dresses, Tops, Shoes, etc., above $XXX and below $XXX. Every retailer needs to rediscover where the demand exists and at what price.

This concept relates to Elasticity and is at the core of the theory of supply and demand. The measurement is to determine how price changes impact demand. Previously, when items stopped selling the retailer would generate a markdown or price reduction to force demand for a product where the real demand had either never transpired (a bad buy) or extinguished as fashion or a season may have changed.

However, now we must look at creating new value in what we sell and aligning that to price models until we recognize an increase in demand. The product mixes must include complement and substitute goods to replace goods that customers have lost interest in at their current price structure.

Part of what I believe is happening in the luxury market is an inverse relationship. For the past 15 years revenue was driven by the prestige of buying luxury and not necessarily in the product itself. As the price of that luxury item diminishes so does the prestige value and thus the demand, especially among the “aspirational” customer, who has evaporated in the current economy. This is called the Veblen effect and is named for the Economist Thorstein Veblen, who was the first to develop the theories of conspicuous consumption. Those customers will now seek more attractive alternatives.

This however opens the door of opportunity. This is a chance to bring in new alternatives at better terms, better markups and in reality to present your customers with more value. This means for the present circumstances, there is lagging interest in labels and increased interest in value. As the prestige element has been removed it needs to be replaced and done so swiftly.

Yesterday is gone, but tomorrow never dies for those who are prepared to seize the moment!

Marc Weiss-
April 09, 2009

Everywhere you look today you see retailers scrambling to turn excess
inventory into cash through heavy markdowns.  The definition of a  recession
is where there is an excess of capacity, inventory and labor in the
marketplace.  The danger for retailers, as it is with other businesses, is
slashing inventory, staff, marketing etc. without a plan. That uncontrolled
strategy will leave them struggling at best and without a business for many.

Retailers need three strategies now instead of just one. Strategy one is
the short term strategy that depends on an accurate sales forecast so you
can adjust the stock to sales ratio down to the new sales level.  Blowing
out merchandise through heavy markdows below that level will starve the
business of needed cash to buy into profitable sales later.

iA midterm strategy will guide buyers into the right levels of merchandise
to buy into as well as the right expense structure to retain in order to
maintain profitable business. There are many aspects to consider in this
crucial period. Negotiating tactics, the Margin Buying Service to provide a
greater margin, aggressive approaches to fixed expenses, aggressive
marketing and customer relationship management as well as a different
mindset for the entire staff are some of the considerations that are
important for success in this midterm approach.  Many shoppers are taking a
hiatus on shopping during this period of chaos and they will come back so
you must be ready.

The final strategy is the long term strategy that will grow your business to
new levels of profitability.  As many as 25% of the retailers will not
survive to join in this process but those that do stand to grow the business
to new levels.  Making that happen requires strategic planning, guidance
based on data and analysis and a team decision process that involves buyers,
sales, an accurate plan and an implementation process to make it work.

Your affiliate will be providing a break even analysis and plans that
reflect changes that serve as the foundation to this process.  Following
that plan is more important now than ever before.