What you’ll learn to do: Examine the merchandise planning process
Imagine you are a Merchandise Planner for a large department store chain and you have been asked to help prepare the plans for the upcoming fall season. How will you assist the buyers in developing their buying plan? Where to start?
You would probably start with a sales forecast by month for the 6-month season. What criteria would you use to confidently predict what those revenue numbers would be? Next, you will need to establish appropriate inventory levels necessary to achieve those sales, support promotions, and stock store presentation of your products. Finally, you would need to determine your end-of-period (EOP) inventory to transition to the following season.
In this section we will review the methods retailers use to develop these plans to maximize sales and minimize markdowns.
- Explain how retailers forecast probable sales numbers for merchandise categories
- Compare and contrast various merchandise assortment options
- Summarize how retailers determine product inventory levels
- Outline a system for controlling merchandise flow
- Describe how retailers decide on merchandise allocations
- Explore the techniques used to evaluate merchandising decisions
Forecasting Sales Numbers
How do retailers forecast sales numbers for merchandise categories?
One of the concepts we discussed in the previous module in the merchandise planning process was forecasting sales. The retail planning process begins with a sales plan. Besides sales history and statistics, you need to have an understanding of your overall business in order to plan increases or decreases which will then dictate proper inventory levels.
Forecasting is also important for a few vital functions within the organization such as human resources, marketing, product management, and operations. It is especially important to product management and operations as they need to understand how much product to produce and warehouse capacity needs!
The merchandise planner helps determine a sales plan based on data from the previous season and the desired sales goals that fall in line with the company strategy. For example, if I am the merchandise planner for women’s swimwear I might decide to plan sales with an increase of 10% over the prior year because I missed sales the previous season and the industry forecasters predict it will be a strong swimwear season. In addition, I might feel my assortment is even more compelling than last year for a number of reasons including better sizing and more desirable styling based on customer feedback.
We must also consider those external factors that influence how we forecast our sales numbers. Every year the National Retail Federation provides an annual economic forecast to help guide the industry of the impact that the external environment is expected to have. Take a look at the video below to understand how those factors influence the industry. As you watch the video consider how the stock market, gas prices, consumer spending, the job market, wage growth, and debt plays a role. Would you say any of these factors are more important the other and which of these impact your decision to spend?
Consider what higher gas prices and a declining job market might mean for retailers that carry luxury items such as expensive handbags and shoes? In a down economy you might find that consumers spend more on basic staple items.
Some categories of business aren’t affected by a downturn in the economy. For example, the beauty industry doesn’t typically see decreased sales patterns during these times. Since the Great Depression the beauty industry has seen sales growth during hard economic times. Why do you believe this is the case? Studies have shown women want to feel good about themselves at all times so they will continue to spend on these “luxury” products that are more like a necessity. So although money might be extremely limited during these times there is always room in a woman’s wallet for those products that will enhance beauty!
We can also look at specific retailers that emerge during tough economic times. Wal-Mart is a great example as their net income rose from 2008-2010 after the financial crisis and subprime mortgage. By offering a vast assortment of core products at value prices they were able to achieve sales growth.
Can you think of any other categories or retailers that aren’t impacted by a down trending economy? Why? How does this impact the decisions the retailer makes?
Merchandise Assortment Options
As we began this chapter we discussed the merchandise management process. You might remember we discussed assortment planning as a key function of merchandise planning. As the seasonal plan evolves, inventory dollars are broken down into categories and further down to specific items. This part of the process is known as assortment planning,
Let’s talk about the What, Why, and How of Assortment Planning.
- What: Assortment Planning is the process of determining product in each merchandise category.
- Why: Retailers increase sales, productivity (turnover), and margin while also improving customer satisfaction.
- How: By identifying store level opportunities as well as how much (breadth of assortment) and in what quantities (depth of assortment) should be carried in a merchandise category.
Assortment Planning Questions
Some key questions that drive assortment planning are:
- What SKUs will drive profitability?
- What key items are essential to your business?
- How does your assortment compare to competition?
- How original are the items within your assortment and how much is duplication?
Assortment Planning Considerations
Before beginning the assortment planning process there are several key considerations.
What is the merchandise capacity of the stores?
Will store capacity fit all of the assortment options I am planning? This can be a little tricky for those chains that have different prototypes across the store base. Another key responsibility of Merchandise Planning is to rank stores by sales performance and other factors to determine their assortment level. All stores might not receive every item in your assortment.
Is there a need for complementary merchandise to service the customer?
If you carry laptops should you carry laptop cases as well? Think about servicing your customer needs completely. If they don’t get it from your store they can go to another store which means you lose sales in this case. At the same time if the customer knows you don’t carry the complementary merchandise they are less likely to visit your store in the future
Is this merchandise profitable?
Before determining if you should carry the item, you need to understand your complete assortment, your margin goals, and the needs of your consumer. You will probably have both low and high margin-producing items in your assortment to service the customer. The mix of both low and high margin producing items might still put you in line with your overall profitability goals. In addition, if you aren’t meeting margin goals on certain items this might be an indication that you need to work with the vendor to reduce the cost of the item.
What are the corporate objectives and does the merchandise align with the strategy and goals of the company and department?
You always want to ensure the goals of your department are in line with the total company strategy. Different retailers will stand for different things: exclusive products, lowest prices to beat competition, designer goods, highest quality products, etc.
What are the regional needs for the area in which I am planning the assortment?
If you work for a retailer with multiple locations across the United States and even the globe this becomes especially important. For example, Florida is a resort area where people often vacation. If you have stores in this area you might consider carrying an extensive assortment of resort-like product such as swimsuits, flip flops, and sunglasses. In addition, if you have stores near any theme parks such as Disney World or Six Flags you might want to carry themed product and other quick travel accessory items such as tote bags. You might even be able to hold a competitive advantage here because those items could be more expensive at the park.
As we wrap of this section of the chapter let’s take a look at a specific example of an assortment plan for missy collection tops. In this plan you can see the sales dollars, receipts, anticipated sell-through, ending inventory dollars and gross margin planned. You can also see the sales and receipt mix percentages.
Example: Excerpts from a Sample Assortment Plan
|Sales $||Rcpt $||Sell Thru %||EOP $||GM %||Sales Merch Mix %||Rcpt $ Merch Mix %||GM $ Merch Mix %|
|* Black Triangle||$25,166||$30,275||83.26%||$5,789||64.54%||7.99%||7.90%||8.03%|
|* Red Triangle||$29,408||$35,125||83.26%||$5,314||64.51%||9.33%||9.23%||9.39%|
|* Blue Triangle||$22,621||$28,545||83.23%||$4,568||64.55%||7.18%||7.10%||7.22%|
|* Yellow Square||$26,580||$32,584||83.26%||$6,657||64.54%||8.43%||8.35%||8.48%|
|* Pink Square||$34,742||$49,568||83.26%||$7,546||61.38%||11.98%||12.91%||11.46%|
|* Orange Square||$25,735||$31,357||83.26%||$5,123||64.54%||8.17%||8.08%||8.21%|
|* Green Diamond||$27,154||$33,582||83.26%||$7,524||64.54%||8.61%||8.52%||8.66%|
|* Purple Diamond||$29,576||$28,543||83.26%||$4,568||64.54%||9.42%||9.32%||9.48%|
|Geometric Collection by Grade|
|Women’s Tees||Sls Tot $/ Avg Str||$11,548||$12,584||$12,684||$11,158||$9,863||$13,138|
|Sls Tot $||$311,395||$37,456||$114,134||$56,134||$76,203||$27,468|
|Sell Thru $ %||83.26%||82.28%||81.99%||82.24%||83.66%||91.65%|
|Rcpt $/ Avg Str||$14,864||$15,578||$15,208||$14,928||$12,392||$15,465|
|Sls Tot $ Loc Mix||100.00%||12.03%||36.65%||18.03%||24.47%||8.82%|
For example, the first item under Women’s Tees (Black Triangle) is 65.54% GM%, 7.99% of the sales and 7.9% of the receipts. What changes would you make based on what you see below? Take a look at Pink Square. Notice anything about that item you would change? If you said you would plan less receipts you are correct! That item is 11.98% of the sales, 12.91% of the receipts, and 11.46% of the gross margin dollars. It has more receipts planned than sales and is producing less gross margin dollars. You might consider decreasing the amount of receipts of this item.
In the lower section of the assortment plan you can see the plan numbers broken out by average store for the assortment. In looking at this plan, you can see how the retailer has developed sales, inventory and purchase levels across the entire organization—broken down by style—and if the assortment makes sense at store level. Notice the level of detail in how the assortment plan applies key metrics to each and every style in the assortment.
Let’s discuss some important characteristics of how retailers determine appropriate inventory levels.
Meet Customer Demand
If you don’t effectively plan your inventory levels you won’t have an understanding of your potential sales given peaks and valleys within the business to meet customer demand. Those peaks and valleys depend on the type of retailer, the seasonality of the product, and the promotional environment. Valentine’s Day product is a great example. There is a relatively short time frame in which any retailer can sell this product category. After February 14th it is likely that the customer will no longer want the products and you will have to markdown any remaining liability to get out of it quickly. Furthermore, if you don’t order adequate amounts of inventory for your shelves prior to the holiday you might miss sales. Imagine the impact this has on an area that only has seasonal product for holidays such as Valentine’s Day—they could potentially miss the sales plan for an entire year!
Every retailer has to factor replenishment lead times in their inventory plans. Lead times can vary from two weeks to six months or more. Order lead time is the time from the placement of the order with a vendor to when the product arrives at the retailer store or warehouse. Domestic product generally has a shorter lead time while product produced overseas have longer lead times. Depending on the area of business this is a key consideration for product that sells out quickly. It might be a good idea to keep warehouse inventory reserve for those items to replenish back to stores that sell out of product.
Sourcing and managing inventory has a direct effect on profitability. A retailer is able to increase profitability if they can control inventory levels. Ignoring a proper inventory system in production, sales, and trade will hinder operational efficiency. If a retailer plans inventory levels in line with customer demand they are able to realize less potential markdowns as they will sell thru the merchandise at a reasonable rate. While it isn’t possible to meet sales objectives 100% of the time there must be a contingency plan in place. Sometimes it is better to markdown product as quickly as possible when it is determined sales objectives won’t be reached to mitigate even more potential risk. In other words, the longer the retailer waits to reduce the price of a slow seller the deeper the discount will need to be.
Better Cash Flow
Policies and procedures for effectively planning inventory levels enable companies to maintain inventory flow, account for inventory value, and handle aged inventory. These are all policies that will enable the company to achieve sales goals and objectives. As a result the retailer is better able to manage cash flow. Why is cash flow important? You might have heard the expression “Cash is King!”. Excellent cash flow works the same way in business that it does for any individual. It allows the retailer to be in a more stable position with regards to spending and buying power. Having cash flow enables any business to generate and use cash. It also allows the retailer to pay any future debts.
For the final segment of this module we will explore the statistical methods the retailer uses to plan inventory levels. These are: forward weeks of supply, weeks of supply, stock-to-sales ratio, sell-through percent, basic stock, and turnover.
Forward Weeks of Supply
An important goal of inventory planning is having enough inventory on hand for the sales planned until the next delivery arrives. This calculation is at the week level and is calculated as the number of weeks of planned sales from the next week forward that current inventory value represents. Using forward weeks of supply is a good metric to make informed merchandise decisions. It gives good insight as to how the product and category will contribute to overall sales and inventory. However, one key disadvantage of forward weeks of supply is it is calculated at a weekly level which doesn’t allow for a higher level top-down approach.
Weeks of Supply
Weeks of supply simply looks at past trend versus any future sales projections. Weeks of supply is calculated as the inventory position for a given period divided by the average sales for that same time frame. One huge disadvantage of weeks of supply is it looks at past sales trend to calculate inventory and not future time periods. It shows you where you have been but not where you are going. This is especially important for those businesses and time periods that have huge sales increases. For example, Easter is a time period in which the sales are typically higher. If you calculate weeks of supply during those time frames it would be much lower than an average time period which would, in effect, make it seem as if you have much lower inventory levels based on weeks of supply. The retailer must always take into account the time period when using this method.
This is an appropriate measure for planning at the monthly level and is calculated by dividing sales at the beginning of period into inventory for that same time period. Stock to sales ratio provides the retailer with an estimated annual turn. However, this measure only looks at one distinct time period and fails to look at the trend over time.
Sell Thru Percent
Sell thru is one of the most common metrics for retailers to understand performance and inventory levels. It represents the ratio of sales to beginning inventory. It is calculated by dividing sales by beginning inventory. This metric, like stock-to-sales ratio, looks at sales in relation to inventory for one period of time as opposed to a longer time period. However, it is useful for understanding performance as well as possible inventory needs. For example, if Product A has a sell thru of 10% and the average for the department is 3%, that is an indication that you need to procure more inventory for Product A to maximize sales potential.
This metric indicates the number of times inventory is sold and replaced over a given period of time. This is usually calculated at the annual or seasonal level by dividing period sales by the average inventory value. Turnover isn’t as effective an inventory method for calculating inventory needs for a short period of time as it is measured over a longer period of time. However, inventory turnover is a key metric that underlies the retail profit formula.
Basic stock inventory planning involves establishing a baseline level of inventory for a given time period. This is a threshold that inventory levels should never fall below. It is calculated as average inventory divided by average sales. This method of planning inventory levels is useful for retailers with consistent-selling items that are not subject to large fluctuations. However, this is not a good method for planning seasonal categories or trend categories where sales are hard to predict. The Basic stock metric is an ideal inventory planning method for replenishment businesses at the SKU (Stock keeping unit) level.
The most important goal of any buyer is to achieve their sales plan. The second most important priority is to keep inventory levels on plan. If you exceed or fall short of your sales plan, the only adjustment you can make to keep your inventory in line is to adjust the flow of incoming merchandise. If you exceed your sales plan, you must accelerate your flow of goods. If you miss your sales plan, you must reduce your merchandise flow. That said, it is not as simple as it looks.
To begin our discussion of controlling merchandise flow, we have to understand how merchandise is procured by retailers vis-à-vis the annual and seasonal planning and in-season merchandise management process. Let us return to our previous scenario where we are in the role of buyer for a national sporting goods and apparel chain.
We have completed our annual and seasonal sales and merchandise plans and are now ready to begin the procurement process to source the goods needed to execute those plans. In general, purchase commitments are made by buyers based on lead times- a concept we introduced in an earlier section. We might begin by working with our internal product production organization on our in-house label line of goods. Typically, these will be designed and sourced by this internal organization and will have the longest lead time.
Next, we would work with our branded suppliers (Nike, Adidas, etc.) to commit for those purchases for the upcoming season. Finally, we would complete our purchases for the upcoming season by filling in our assortment with other domestic vendors’ products.
Now that purchase commitments have been made by our national sporting goods and apparel buyer, we enter the planned selling season. This is where the concept of controlling inventory flow is crucial to a retailer’s success. How does the buyer now control that merchandise flow to keep the inventories on plan as sales occur? There are two primary systems for doing so: Supply Chain Management (SCM) and Open-To-Buy (OTB).
We discussed the concept of SCM in an earlier section- a system where the retailer partners with vendors to control all aspects of product production to deliver goods to the retailer as planned. Since SCM systems are controlling production and transportation of product, it is possible to utilize the system to increase or decrease the flow of goods to the retailer. However, keep in mind that due to the longer lead times and overall complexity of a SCM system, there is less flexibility to make large adjustments on the fly short-term.
Using OTB is the primary means retailers use to control the flow of goods in the selling season. Here is a simple Open-To-Buy Formula:
B.O.P Inventory − Sales − Markdowns − E.O.P Inventory Plan = Open-To-Buy
So let’s plug in some values to see how the formula works: Assume we start with a Beginning of Period (B.O.P) inventory of $500,000.00. We experience sales of $100,000.00, markdowns of $25,000.00, and our inventory target for the End of Period (E.O.P) is $600,000.00. What would be our OTB?
$500k (BOP) − $100k (Sales) − $25k (Markdowns) − $600k (EOP) = $225k (OTB)
In this example we see an OTB of $225k (using this formula will yield a negative number but we retailers use absolute value to keep the OTB a positive integer). To double-check your math, you can plug the OTB into the calculation as “Purchases” to ensure you are hitting your EOP target:
$500k (BOP) − $100k (Sales) − $25k (Markdowns) +$225k (Purchases) = $600k (EOP Inventory)
Keep in mind that these methods will vary depending on retail organization size, sophistication, business goals, strategies and category of goods.
Merchandise allocation is the process of determining how to distribute merchandise to individual store units for maximum sales and minimal markdowns. Depending on the size and sophistication of the retail operation, this can be a simple process, or an extremely complex algorithmic exercise. Some retailers plan their season’s purchases from the ground up based on ideal store allocation, or others use the allocation process to break down merchandise receipts to allocate to online warehouse distribution, regional distribution centers or direct to stores.
In additional to the math of the process, there are strategic and tactical considerations for merchandise allocation as well. Stores in their “grand opening” phase will receive maximum merchandise allocation to both make an impact to new customers and to help determine the sales potential of the new store unit for future allocation accuracy. Allocation can also be influenced by a competitive strategy where a retailer is attempting to make a “show of strength” with wide assortments and deep quantities for a more favorable impression when compared their competitors inventory position.
As you would imagine, commercial software applications have been developed to assist retailers in the computational-heavy process of merchandise allocation. Vendors such as JustEnough, RELEX, Logility, JDA Software, Oracle, and many others compete in this space. Here are some screen shots of a package from JustEnough, to give you an idea of the capabilities of these applications.
In the first, screen shot you can see the individual store locations broken out and the allocation percentages listed based on performance metrics. The second screen shot is more focused on a category of merchandise grouped by style with exception reporting enabled.
Like all businesses, retailers must evaluate their performance on a regular basis in order to continue success, improve results, or turn-around sub-par situations. Based on the condition of the retail industry today, one might say that it is more crucial than ever to get it right. Given the different kinds of retailers it is difficult to make general statements regarding the methods used to evaluate merchandise decisions. Dick’s Sporting Goods would have a somewhat different perspective than 7-11. Macy’s would review their business differently than Big O Tires.
Despite the differences between retailers, there is one major common factor: the degree of complexity within their businesses. A review of retailer merchandise decisions reflects this complexity, revealing all of the dimensions of merchandise organization. Retail merchandise organization can be broken down from a product perspective: group, division, department, vendor, classification, sub-class and SKU. Another dimension of review could be a location perspective: region, area, district, store, department, classification and SKU. Layer on to that the time dimension: year, season, quarter, month and week. Retailers then take these various dimensions and find points of intersection depending on the level of the business undergoing analysis.
Retail merchandise analysis in usually performed both at a financial level and a unit level- again owing to the degree of complexity and level of detail needed to manage and analyze merchandise decisions.