Margin Hunting Is Never Out of Season

 
 
A half-century ago we learned to respect gross margin return on investment (GMROI) as a tool for measuring the profitability of merchandise on store shelves. For the first time we were able to drill down to specific classifications and analyze how productive they were in each location, allowing management to make intelligent decisions. Whether it was hats or sporting goods, items that did not contribute to the bottom line were eliminated from specific stores — or from a company’s assortment.

Today there is much greater sophistication and most companies have a more-focused merchandise assortment that addresses their specific customer profile. Stores now get consumer recognition for having the right merchandise at the right time.

Professor Marshall Fisher of the Wharton School of the University of Pennsylvania wrote in the Harvard Business Review about how flexible manufacturing and rapid logistics help improve performance for suppliers and retailers alike. He feels that managers lack a framework for deciding the supply chain characteristics that are the best for their companies’ situations. In Professor Fisher’s view, an understanding of the nature of the demand for their products can provide retailers with insights into the type of supply chain that can best satisfy the demand.

Several companies focus on providing this sort of insight. Through its ProfitLogic applications, Oracle’s Retek answers some of the questions – particularly the timing of markdowns and when it is most profitable to take them. A newer company, Berwyn, Pa.-based 4R Systems, recently demonstrated for me its approach to stocking merchandise in a way that effectively responds to consumer demands, thereby generating higher gross-margin dollars.

Predicting inventory demand
4R Systems models demand at the SKU/store levels and describes demand not as a single number, but as a pattern of variation. The company believes that a model of inventory profitability drives profits more efficiently and accurately than real-world trial and error, thereby generating better profits. Learning to rely on and trust such a model would be a big shift for retailers.

In order to understand a potential client, 4R Systems analyzes one to two years of historical data, from which it generates an estimate of the increase in profit that can be expected. As part of this process, there will be detailed information that shows which SKUs will expand inventory and which will shrink; this will have a major margin impact. Subsequently, there will be a determination as to which stores will have more or less inventory and the margin impact those decisions will have.

Executives of Crate & Barrel, Family Dollar and other retailers are enthusiastic about the capabilities of 4R. They feel that the inventory management system has added to their profitability on a sustainable basis. I believe that an assortment and inventory depth that is tailored to consumer demand is a profitable way to build a successful business.