THE PROFIT LAB // 10 Steps to Finding Profit in Localized Replenishment
5. LOCK IN THE TARGET BEFORE LOADING THE INVENTORY //
Step #5: Lock and load
The previous post in this series discussed establishing your goal. What is it you’re that trying to achieve? Odds of getting to the ideal inventory answer without knowing the goal are slim. That goal becomes the driver that helps us identify what inventory position we should stock to.
A major part of determining the goal is assigning the role of a product. Once the role of a product in the assortment is established (e.g. traffic driver, money item, fringe item, image item, etc.) it provides guidance that can be used to direct inventory targeting. If we use a traffic driver for example, the goal is to have a high in-stock because we don’t want to disappoint customers who shop specifically for that item and are likely to buy other things while in the store. If we translate this into a metric value that you have available to drive your inventory targets, you’ll be more aligned with the goals of each product. This perspective will allow you to more appropriately define targets than common approaches that focus mainly (or entirely) on sales volume.
Since most traditional replenishment systems use a service level target as the inventory driver, we can use that to accomplish the objective. In the case of the traffic driver, a very high service level is implied. Due to the nature of a traffic driver we can think of missing a sale as being more costly for these than other items because of the implication that other sales will be lost if we lose this item’s sale. These items will, therefore, have some of the highest service targets of any products.
The process becomes a bit more complex when we start looking at other roles such as money items. Money items are all about profitability so the goal is to find the target that maximizes selling without being subject to overstocks, which erode profitability. In traditional environments, we are again constrained to using service level as a driver so an analysis and a few assumptions will be required to find the appropriate targets. Margin will have an impact on the answer as well. For example, an item with a high margin can lean toward a slightly higher service level since the value of having an extra unit that may capture a possible sale is less than the cost of a markdown that might result. If margins are tighter, we need to be more conservative since the cost of markdowns and/or holding can more quickly slash margin and profit.
Similar logic can be applied to any role you define for products in the assortment. It’s also necessary to consider the remaining life of a given product. A product that is approaching the end of its life will have more margin exposure (due to inevitable markdowns ahead) than an item that has a long lifespan.
What can you do now?
First, define product roles and translate those into high-level definitions of what they mean as objectives relating to inventory. Since most traditional systems are driven by service level targets we must then begin to analyze the facts that reside in historical performance to determine what levels of service result in achieving the measures each role implies. How much service leaves you with a profitable ratio of inventory (money item)? How much service enables you to capture as many sales as possible without resulting in carrying an unacceptable level of inventory (traffic)? How much service enables you to minimize inventory investment and perhaps purposely be out of stock occasionally but not so much that the image that item represents isn’t lost (image)? How much service enables you to capture sales opportunistically but sell through quickly with little exposure to carrying costs or markdowns (fringe)? And so on and so forth.
What should you consider in the future?
If you’re investing in a new technology, this is an area where more modern solutions really begin to distance themselves from traditional approaches. Modern, sophisticated replenishment systems actually evaluate the literal profitability results that any given inventory decision results in and does this uniquely for each product-location combination. Some of these systems also consider impacts to profit including cost of holding merchandise and impact of likely future markdowns. Better systems actually work across multiple objectives to ensure more complex goals can be met. The best actually evaluate their past inventory recommendations and measure success, which are learned from and applied to future decisions so results continuously improve. If you’re investing in new technology this area of inventory targeting is one dimension that can have a surprisingly large impact on the quality of results.
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