McGraw-Hill/IrwinRetailing Management, 7/e © 2008 by The McGraw-Hill Companies, All rights reserved.

Managing Merchandise Assortments

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Questions

■ How is the merchandise management process organized?

■ Why do the merchandise management processes differ for staple and fashion merchandise?

■ How do retailers evaluate the quality of their merchandise management decisions?

■ How do retailers forecast sales for merchandise classifications?

■ How do retailers plan their assortments and determine the appropriate inventory levels?

■ What trade-offs must buyers make in developing merchandise assortments?

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Merchandise Management

Process by which a retailer offers the correct quantity of the right merchandise in the right place at the right time and meets the company’s financial goals.

■ Sense market trends■ Analyze sales data■ Make appropriate adjustments in

prices and inventory levelsc) image100/PunchStock

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Buying Organization

Merchandise Group

Department

Classification

Category

SKU

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The Buying Organization

Merchandise Group…………Men’s wear

Department………….……….Young Men’s wear

Classification………….……..Pants

Category……………………..Jeans

Sock Keeping Unit (SKU)…..Levi, 501, size 26 waist, 32 inseam

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Merchandise Classifications and Organization

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Merchandise Category – The Planning Unit

A merchandise category is an assortment of items that customers see as substitutes for each other.

Vendors might assign products to different categories based on differences in product attributes

Retailers might assign two products to the same category based upon common consumers and buying behavior

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Category Management

Breakfast cereal category vs. Kellogg Corn FlakesMen’s knitted shirts vs. Polo shirtsDiary product category vs. Carnation milk products

■ The process of managing a retail business with the objective of maximizing the sales and profits of a category

■ Objective is to maximize the sales and profits of the entire category, not just a particular brand

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Category Captain

Selected vendor responsible for managing a category

Vendors frequently have more information and analytical skills about the category in which they compete than retailers

■ Helps retailer understand consumer behavior■ Creates assortments that satisfy the customer■ Improves profitability of category

Problems■ Vendor category captain may have different goals than

retailer

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Evaluating Merchandise Management Performance - GMROI

Merchandise managers have control over■ The merchandise they buy■ The price at which the merchandise is sold■ The cost of the merchandiseMerchandise managers do not have control over■ Operating expenses■ Human resources■ Real estate■ Supply chain management■ Information systems

SO HOW ARE MERCHANTS EVALUATED?

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GMROIProductivity Measures

Inventory Gross Margin

Input Output

A measurement of how many gross margin Rupee are earned on every rupee of inventory investment made by the buyer

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Managing Inventory Turnover

Inventory turnover = Net Sales Average inventory at retail

Inventory turnover = Cost of goods sold Average inventory at cost

Average inventory = Month1 + Month2 + Month 3 +… Number of months

■ Inventory Turnover helps assess the buyer’s performance in managing asset (merchandise inventory)

■ But focusing on increasing inventory turnover can actually decrease GMROI■ Buyers need to consider the trade-offs associated with managing Inventory Turnover

Calculation

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Inventory Turnover

Month Retail Value of Inventory■ EOM January $22,000■ EOM February 33,000■ EOM March 38,000■ Total Inventory $93,000

■ Average inventory = $93,000 ÷ 3 = $31,000

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Inventory Turnover and Stock-to-Sale Ratio

Inventory turnover = Net Sales (at retail) Average inventory at retail

Inventory turnover = Cost of goods sold(at cost) Average inventory at

cost

Sock-to-Sales Ratio = Net Sales Average cost of

inventory

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GMROI = Gross Margin Percent x sales-to-stock ratio

= gross margin x net sales

net sales avg inventory at cost

= gross margin

avg inventory at cost

Inventory Turnover

= (1 – Gross Margin Percent) x sales-to-stock ratio

GMROIGross Margin Return on Investment

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ROI and GMROIAsset Productivity Measures

Strategic Corporate Level■ Return on Assets = Net Profit

Total Assets

Merchandise Management Level■ GMROI = Gross Margin

Avg. Inventory at Cost

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Illustration of GMROI

Merchandise categories with different margin/turnover profiles can be compared and evaluated

Canned food

Canned food

Fresh Bakery

Fresh Bakery

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GMROI for Selected Department in Discount Stores

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Advantages of Rapid Turnover

■ Increased sales volume■ Less risk of obsolescence and markdowns■ Improved salesperson morale■ More resources to take advantage of new

buying opportunities

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Approaches for Improving Inventory Turnover

■ Reduce number of categories■ Reduce number of SKUs within a category■ Reduce number of items in a SKU

BUT if a customer can’t find their size or color or brand, patronage and sales decrease!

another approach…

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…another approach

To improve inventory turnover■ Buy merchandise more often■ Buy in smaller quantities which should reduce average

inventory without reducing sales

BUT by buying smaller quantities■ Buyers can’t take advantage of quantity discounts so■ Gross margin decreases■ Operating expenses increase■ Buyers need to spend more time placing orders and

monitoring deliveries

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Merchandise Planning Process

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Types of Merchandise Management Planning Processes

■ Staple (Basic) Merchandise Categories Continuous demand over an extended time period Limited number of new product introductions Hosiery, basic casual apparel Easy to forecast demand Continuous replenishment

■ Fashion Merchandise Categories In demand for a relatively short period of time Continuous introductions of new products, making existing

products obsolete Athletic shoes, laptop computers, women’s apparel

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Merchandise Management Process

1. forecasting sales

2. Developing an assortment plan

3. Determining the appropriate inventory level

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Developing a Sales Forecast

■ Understanding the nature of the product life cycle■ Collecting data on sales of product and comparable

products■ Using statistical techniques to project sales■ Work with vendors to coordinate manufacturing and

merchandise delivery with forecasted demand .

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The Category Product Life Cycle

Knowing where a category is in its life cycle is important in developing a sales forecast and merchandising strategy

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Types of Merchandise

Staple Merchandise

Predictable Demand

History of Past Sales

Relatively Accurate Forecasts

Fashion Merchandise

Unpredictable Demand

Limited Sales History

Difficult to Forecast Sales

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Forecasting Staple Merchandise

Based on extrapolating historical sales because sales are constant from year to year

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Work with Vendors:Collaboration, Planning, Forecasting, and Replenishment Systems (CPFR)

■ Vendors have proprietary information about their marketing plans (e.g., new product launches, special promotions)

■ Procedures used by retailers and vendors to work together to insure that the right merchandise is at the right place at the right time.

Benefits both retailers and vendors Increases fill rate, reduces stockouts, increases inventory turns

www.cpfr.org

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Developing Assortment Planning

Assortment plan is a list of the SKUs that a retailer will offer in a merchandise category and reflects the variety and assortment that the retailer plans to offer in a merchandise category

Variety (breadth) is the number of different merchandising categories within a store or department

Assortment (depth) is the number of SKUs within a category.

Product availability defines the percentage of demand for a particular SKU that is satisfied.

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Is This Store Heavy on Variety? On Assortment?

PhotoLink/Getty Images

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Determining Variety and Assortment

Buyers consider■ Retail strategy

The number of SKUs to offer in a merchandise category is a strategic decision

■ GMROI of the merchandise mix■ Trade-off between too much versus too little assortment

Increasing sales by offering more breadth and depth can potentially reduce inventory turnover and GMROI by stocking more SKUs

■ Physical characteristics of the store■ Complementary Merchandise

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Assortment Plan for Girls’ Jeans

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Importance of Backup (Buffer) Stock

Choosing an appropriate amount of backup stock is critical to successful assortment planning

■ If the backup stock is too low loose sales and customers

■ If the backup stock is too high scare financial resources will be wasted on needless inventory that could be more profitably invested in more variety or assortment

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Assortment Planning – A Key to Financial Success

Financial success

=good

assortment strategy

+good

assortment execution

Right Product

Right Place

Right Time

Right Quantities+ + + =

Happy Customer

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For A Retailer, These Situations Are Very Costly

• Objective of assortment planning system is to match Inventory to demand– By quantity– By size– By geography– By store format

• Mismatch Results In Serious Consequences– Overstocks create markdowns and

lost gross margin dollars– Under stocks create lost sales and

unhappy customersA retailer was stuck with $400 million in excess inventory…after misreading consumer demand for products at the right price point.

--Forrester Research

”“

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Basic Stock

Indicates the Desired Inventory Level for Each SKU

Cost of CarryingInventory

Lost Sale Due to Stockout

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Factors Determining Backup Stock

■ Higher product availability (service level) retailer wishes to provide to customers

■ Greater the fluctuation in demand■ Longer lead time from the vendor■ More fluctuations in lead time ■ Lower vendor’s Fill rate (% of

complete orders received from a vendor)

MoreBackup Stocks

Needed with

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Staple Merchandise Management

Ryan McVay/Getty Images

Most merchandise at home improvement centers are staples.

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Inventory Management Report for Rubbermaid Merchandise

Inventory available

sales rate

Performance measures

Backup stock for desired product availability

desired product availability

Sales forecasts

Appropriate ordering decisions

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Order Point

the point at which inventory available should not go below or else we will run out of stock before the next order arrives

Order point = sales/day (lead time + review time) + buffer stock

■ Assume Lead time = 3 weeks, review time = 1 week, demand = 100 units per week

Order point = 100 (3+1) = 400

■ Assume Buffer stock = 50 units, then

Order point = 100 (3+1) + 50 = 450We will order something when order point gets below 450 units.

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Calculating the Order Point

In a situation in which the lead time is two weeks, the buyer reviews the SKU once a week, 18 units of backup stock are needed to maintain the product availability desired, and the sales rate for the next four weeks is 5.43 per day. Order Point?

Order Point = (Demand/Day) x (Lead Time +Review Time) + Backup Stock

132 units = [5.43 units x (14 + 7 days)] + 18 unitsSo Buyer Places Order When Inventory in Stock Drops Below 132 units

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Order Quantity

When inventory reaches the order point, the buyer needs to order enough units so the cycle stock isn’t depleted and sales dip into backup stock before the next order arrives.

Order Quantity = Order Point – Quantity Available

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Inventory Management Report for Rubbermaid SKUs

Quantity available = Quantity on Hand + Quantity on Order = 90Order Quantity = Order Point – Quantity AvailableOrder Quantity = 132 – 90 = 42

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Fashion Merchandise Management Systems

The system for managing fashion merchandise categories is typically called a Merchandise Budget Plan

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Merchandise Budget Plan

■ Plan for the financial aspects of a merchandise category

■ Specifies how much money can be spent each month to achieve the sales, margin, inventory turnover, and GMROI objectives

■ Not a complete buying plan--doesn’t indicate what specific SKUs to buy or in what quantities

Royalty-Free/CORBIS

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Steps in Developing a Merchandise Budget Plan

■ Set margin and inventory turn goals■ Seasonal sales forecast for category■ Breakdown sales forecast by month■ Plan reductions – markdowns, inventory loss■ Determine stock needed to support forecasted

sales■ Determine “open to buy” for each month

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Six Month Merchandise Plan for Men’s Casual Slacks

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Shrinkage

Inventory loss caused by shoplifting, employee theft, merchandise being misplaced or damaged and poor bookkeeping.

Retailers measure shrinkage by taking the difference between

1. The inventory recorded value based on merchandise bought and received

2. The physical inventory actually in stores and distribution centers

Shrinkage % = $ shrinkage

$ net sales

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Steps in Determining the Stock-to-Sales Ratio

Step 1: Calculate Sales-to-Stock Ratio

GMROI = Gross margin% x Sales-to-stock ratio

Sales-to-Stock Ratio = GMROI/Gross margin %

■ Assume that the buyer’s target GMROI for the category is 123%, and the buyer feels the category will produce a gross margin of 45%.

Sales-to-Stock Ratio = 123/45 = 2.73

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Steps in Determining the Stock-to-Sales Ratio Continued

Step 2: Convert the Sales-to-Stock Ratio to Inventory Turnover

Inventory Turnover = Sales-to-stock ratio x (1 – GM%/100)

Inventory Turnover =2.73 x (1 – 45/100) = 1.50

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Steps in Determining the Stock-to-Sales Ratio Continued

Step 3: Calculate Average Stock-to-Sales Ratio

Average Stock-to-Sales Ratio = 6 months/Inventory turnover

= 6/1.5 = 4

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Steps in Determining the Stock-to-Sales Ratio Continued

Step 4: Calculate Monthly Stock-to-Sales Ratio

• Monthly stock-to-sales ratios vary in the opposite direction of sales

• To make this adjustment, the buyer considers the seasonal pattern, previous years’ stock-to-sales ratios

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BOM Stock (Line 6)

6. BOM Inventory 6 mo. data April May June July Aug Sept 98280 98280 68460 68640 98800 98280 8000

BOM Stock = monthly sales (line 2) x BOM stock-to-sale ratio (line 5)

= $27,300 x 3.6

= $98,280

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End-of-Month (EOM) Stock (Line 7)

7. EOM Inventory 6 mo. data April May June July Aug Sept 85600 68640 68460 275080 98280 78000 65600

The BOM stock for the current month = the EOM stock in the previous month

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Monthly Additions to Stock (Line 8)

8. Monthly additions to stock 6 mo. data April May June July Aug Sept 113820 4260 17910 48406 26180 8670 8420

Additions to stock

= Sales (line 2) + Reductions (line 4) + EOM Stock (line 7) – BOM Stock (line 6)

Additions to stock (April)= $27,300 + $6,600 + $68,640 - $98,280 = $4,260

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Evaluating the Merchandise Budget Plan

■ Inventory turnover GMROI, sales forecast are used for both planning and control

■ After the selling season, the actual performance is compared with the plan

Why did performance exceed or fall short of the plan? Was the deviation from the plan due to something

under the buyer’s control? Did the buyer react quickly to changes in demand by

either purchasing more or having a sale?

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Open-to-Buy System

The OTB system is used after the merchandise is purchased

Monitors Merchandise Flow

Determines How Much Was Spent and How Much is Left to Spend

PhotoLink/Getty Images PhotoLink/Getty Images

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Six Month Open-to-Buy

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Allocating Merchandise to Stores

Allocating merchandise to stores involves three decisions:

■ how much merchandise to allocate to each store

■ what type of merchandise to allocate

■ when to allocate the merchandise to different stores

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Inventory Allocation Based on Sales Volume and Stock-to-Sales Ratios

Smaller stores require a proportionally higher inventory allocation than larger stores because the depth of the assortment or the level of product availability is too small, customers will perceive it as being inferior.

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Multiattribute Method for Evaluating Vendors