Fundamentals of Inventory Management NCOF 2011 … to substantiate an organization’s objectives ... • Are there limits? – False conclusions ... Fundamentals of Inventory Management

Fundamentals of Inventory Management For Direct Marketers

NCOF 2011

Prepared by: George Mollo, 2011, All Rights Reservedwww.gjmassociates.com

Fundamentals of Inventory Management for Marketers

Presented By: George MolloGJM Associates, Inc.www.gjmassociates.com(845) 627-0788

GJM Associates, Inc.www.gjmassociates.com(845) 627-0788

Introduction

GJM Associates, Inc. www.gjmassociates.com is a consulting firm that focuses on all aspects of merchandising operations for direct marketing companies. Our primary focus is supply-side processes, that start with merchandise analysis and planning, includes inventory management strategies and the critical coordination of merchandising, marketing, finance, creative and operations through all elements of the business to the ultimate and profitable fulfillment to a customer.

George is also Senior Partner of The Turnaround Specialists, the premier source for rapid, effective and efficient turnaround of multi-channel direct response catalog and retail businesses. www.theturnaroundspecialists.com

• 12 years Retail• 3 years Wholesale• 15 years Catalog• 10 years Consultant• 2002-2007 Served as Chair of the DMA’s Catalog & Multichannel Marketing Council• Speak at conferences (User Groups, NCOF, ACCM, Retail Marketing Conference, European Catalog

Mail Order Days)**• Contributes articles for trade publications**

(**PDF copies available on www.gjmassociates.com)

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Overview

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Agenda

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Agenda

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Agenda

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Inventory Impact

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Why is Inventory Management so Important?


Inventory Impact

Properly controlled inventory can move substantial profit $$ to (or from) bottom line

Examples: – $50m business - every 1% increase in final fill

increases $500k to net sales (which also reduces potential overstock; most other costs except variable have already been spent.)

– Assuming a 5% EBITDA --- a 1% increase in final fill could increase profit by 10%

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Why is this Important?

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Inventory Management Hub

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Key Performance Indicators11


Defining KPI

Performance Indicators (KPI): Separate the “winners” from the “try agains;”and knowing not only what to measure, but also how to measure it and what it all means, is what separates and defines levels of success.

You can’t fix what you don’t measure!!!

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Defining KPI

• a quantifiable measurement that can be tracked and evaluated, and that is harmonious with what you want to achieve

• a metric that an organization measures to help determine its progress towards a goal

• a reflection of the tactical performance of an organization; and, is used to substantiate an organization’s objectives

• can be quantitative or qualitative, objective or subjective, although preferably quantitative, unambiguous, and reliable

• a critical measurement of the performance of essential tasks, operations, or processes. A KPI will usually unambiguously reveal conditions or performance that is outside the norm and that signals a need for managerial intervention

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What are the Key Measures?14


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Key Measures

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Key Measures

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Other Measures

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Key Measures & Definitions

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Backorders

• Is there an acceptable rate?• Relationship to Final Fill Rates?• Cause of Backorders?

– 30-40% of backorders are caused by bad timing, not bad forecasts

• Internal communications– Call center– Distribution center– Management

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Backorders: Improving Communication

• Weekly Top 10/20 Backorder list to:– DC (Receiving)– Call Center– Management

Include Item, description, units & dollars on BO, expected delivery date, expected quantity, comments

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Returns

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Reducing Return Rates

• Communication to DC – expedites processing to fill backorders

• Quarterly Review Committee with Call Center/Customer Service & others

• Address Top 10/20 returns

Instituting this approach, I have experienced 25% reductions in overall return rates

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Inventory Turns

Inventory Turns = Annual Cost of Goods Sold / Average Inventory (at cost)**

**Average includes 13 periods……

Example: $10.0mil COGS / $ 3.1mil Avg. Inv = 3.23 annual turns

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Setting Benchmark Goals

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Benchmarks

Apparel Hard GoodsReturns 16-18% 5-8%Cancels 7-9% 3-5%Initial Fill-item 78-83% 87-89%Initial Fill-order 77-80% 83-85%Final Fill-item 91-94% 95-97%Final Fill-order 90-93% 95-97%

Cost of a back order $8-13 $10-13

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Demand• Why is it Important to Capture all Demand?

– Shadow/Lost Demand (web considerations)

• Are there limits? • Not sure? – Test Order w/ mixed BO & in stock

Could add 10-20% to existing “sales”

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Hidden Costs

Capturing all Demand– Lost Demand

• Are there limits?– False conclusions

• dropping wrong items/colors• Buying wrong items (overstock)

– “Hidden Impacts”• Increased list rental costs• Name acquisition costs• List analysis• Overstated fill rates• Lower fill rates and increased overstock across the board

(example: Disney art cell)– greater risk with wide variation in price points offered

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Planning & Forecasting29

Merchandising Strategy30


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Merchandising Strategy

• Product Categories should be main focus of business– Target 10-12 categories *– Sub-categories define further– Don’t over assort, e.g. Shirts > 40% of total – Avoid “Paradox of Choice” **

• Consistent with Brand• Provide a merchandising “statement” to the

customer

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* Define categories based on product offerings and “end use”. Be careful of “themes” as comparison. ** “Paradox of Choice: Why More is Less,” Professor Barry Schwartz, Univ. of Pennsylvania



Assumptions:• Products fatigue if not reinvented or renewed (especially as house

mailings comprise 60-80% of the mix; repeat web customers)• Best customers need more newness because of their interest in

the book/website and rate of purchasing activity• The cost of paper and postage will continue to increase• Competition will continue to increase in all distribution channels.

(MO/E-commerce).• No more than 1/3 of new products are winners

– Perform above book average– Are profitable

• Repeat items planned at breakeven margin - will do worse• Repeats can suffer 25-35% attrition rates with each additional

insertion

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Axiom 1: Sales in a typical offering, regardless of

product category, are distributed across items as follows.

Best selling 1/3 2.00x book averageMiddle 1/3 .80x book averageBottom 1/3 .26x book average

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Axiom 2As the space given to an item * is

increased or decreased the impact on sales is equal to between 1/3 to 1/2 of the change. (aka “Rule of 50”)e.g. If we increase the space devoted to an item by 60% we would expect the sales of the item to increase by 20 to 30%.

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* Same is true of circulation, pages, item counts, etc. etc.


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Merchandise Assortment Planning(MAP)

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Merchandise Assortment Planning

“Adopting a well grounded merchandising plan is far and away the single most important thing a company must do for success.

The key to growing sales and profits, providing better direction to the merchants invariably results in better product selection.

More and better products lead to increased response rates, which in turn expand the universe of names that can be mailed/emailed profitably, increasing circulation and sales.”

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Start at the Beginning

Establish a Pre-Season “Kick-Off” meeting• Representatives from all departments

Each Department should Discuss:• Review of post season results• “What worked, what didn’t”• “Direction for new season”• Potential “issues” that might arise

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Merchandise Assortment Planning

• Based on History, Analysis & “Gut”• When?: 9-12+ months in advance• Take A Simple & General Approach• Improve majority of items - Don’t try for 100%

accuracy on all items“ALMOST” Right NOW is better than…

“EXACTLY” Right Later !”

• Start at Category Level (Top Down – then Bottom Up)

• Why a Detailed Plan?• Sum of the parts will always be greater than the whole!

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Planning Factors

What do we need to get started? (12+ months in advance?)• Timing of Book/Offering (comparability)• Size of book (pages – excluding “sale grids”)• Density – based on historical• Estimated Demand

Merchandisers “complaints”• The “MAP” is not written in stone and can be changed

Anything else required? No ---

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Planning Factors (Category)

Four Key Factors:• Item Counts (based on pages/density)

• Web: low cost to add products but consider inventory investments (warehouse costs, etc.)

• Demand• Space Allocations• Page Space Costs (not “necessary” but…)

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Planning Factors

• Item CountsQuestion: How can we determine item

counts 9-12+ months in advance?

Function of pages & density – which are relatively constant

** Web item counts can also get out of control

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Planning/Forecasting Factors

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Category/Sub-Category Plan43


Additional Metrics (Category) Level

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Creating Indices

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Category (MAPS) View

rAii

Description Items % Dmd % Avg Itm P I Mrgn Space % S I SRNet Mgn

TOTAL DROP: 314 100.0% 5985.0 100.0% 19,061 1.00 57.9% 64.00 100.0% 1.00 43.1% 14.8%

GIFTS 87 27.7% 1310.7 21.9% 15,066 0.79 61.0% 15.00 23.4% 0.93 46.1% 14.9%

HOME 72 22.9% 1472.3 24.6% 20,449 1.07 54.6% 17.00 26.6% 0.93 46.5% 8.1%

APPAREL 53 16.9% 1897.2 31.7% 35,797 1.88 59.8% 15.00 23.4% 1.35 31.8% 28.0%

ACCESSORIES 102 32.5% 1304.7 21.8% 12,791 0.67 55.4% 17.00 26.6% 0.82 52.5% 2.9%

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Additional Measures

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AVERAGES

Overview Analysis: • Page Average• Spread Average• Item Average

If calculated as an index --- provides directional information and highlights anomalies.

Remember: “Almost Right NOW……”

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Additional Tips & Tricks

Price Point Analysis

• Ensures you have covered key ranges• Guides price point selections

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Positive Profit Impacts

Horizon Planning - Benefits to Other Areas• Creative costs can be substantially reduced

– Factor creative lead times to add/drop items to match inventory availability

• DC supplied forecasts for bin “profiling” and setup

• Last minute exceptions - handled more efficiently

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Positive Profit Impacts

• Inventory Buying can be “Scheduled” on a “Horizon” (and allow for less costly changes)

• Dramatic positive impacts to cash flow• Reduced backorders & reduced overstock• Higher fill rates (both initial and final)• Increased “Bottom Line”

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It’s All in RELATIONSHIPS !

Use Multiple Measures –Referenced to Each Other

• Category Share• Item Count (density)• Page Space• Demand (Book & Item)• Page or Spread Average• Etc…...

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Item Forecast Considerations53


Item Selections

Techniques to Improve Item Selection• Use Assortment Plan as “control”• Finance can create an “Open to Buy”

control• Consider “competition”• Do not “over-SKU”• Consider “extra costs” (e.g. creative,

packaging, shipping, etc.)

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Item Forecasting Factors

• Presentation (Size)• Creative Factors• Location in Catalog

(key positions)• Demand History• Price Points• Circulation

(Qty/Target)• Item Counts (Density)• Competition (Int/Ext;

also pricing)

• Space• Space Costs (Sell

Ratio)• Item Relationships

(Ranking A - B - C)• Seasonality• Indices• Customer perceptions

(item relationships or creative perception)

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Methods of Forecasting

Forecasts “tied out” – Top Down AND Bottoms Up56


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Percent Done

• What percent done is statistically sound?• Using “book” percent done….• Are all items equal?• How many trend curves?

– When using “trend curves” generally 3 to 5 will suffice (Keep it simple!)

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Percent Done

Advantage:• Items can be forecasted quickly• Excellent “benchmark”

Disadvantage:• Not all items perform the same to book• Results can create overstocks and out of

stocks

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AII (Average Item Index)

Advantages: • Consistent Item Comparison Base within same

drop/catalog• Consistent Item Comparison Base

between/across drops/catalogs• When forecast changes – Index doesn’t

change, only value does

Demonstrates Relationships (To Overall Average & Other Items)

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AII (Average Item Index)

Disadvantages:• Space must be factored (full page,

cover vs. average)• Seasonality must be factored

*However, Space and Seasonality changes are easy to identify

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Average Item Index

Item # Description drop 1 drop 2 drop 3 drop 4 drop 5 drop 6

Item A l/s shirt 2.0 1.8 1.6 1.3Item B s/s shirt 0.4 1.4 2.0 5.0 2.5 1.8Item C plaid shirt 1.0 0.8 1.0Item D henley shirt 0.9 1.0 1.0Item E pique polo 2.0 2.0 2.2 2.1 2.1 2.0Item F interlock polo 2.0 1.9 1.8 1.9 1.9 1.9

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Item # Description drop 1 drop 2 drop 3 drop 4 drop 5 drop 6

Item A l/s shirt 2.0 1.8 1.6 1.3Item B s/s shirt 0.4 1.4 2.0 5.0 2.5 1.8Item C plaid shirt 1.0 0.8 1.0Item D henley shirt 0.9 1.0 1.0Item E pique polo 2.0 2.0 2.2 2.1 2.1 2.0Item F interlock polo 2.0 1.9 1.8 1.9 1.9 1.9

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Average Item Index


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Forecasting Repeat Items

• What % of items are Repeat vs. New Items• Review History

• Identify Similar Items• Consider “Wear Out” factors• Review Relationships to other product

(especially competing new product)• Profit Projections (Is the item still justified?)

– Suggestion: Add inventory carrying cost to margin calculation…

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Forecasting New Items

• Identify Similar Items• Varying Rules -- New Items should be >

20% of average• Review Relationships to other product• Consider competition (Internal & External)• Profit Projections (Is the item justified?)

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Other Forecasting Factors

• Final Item Forecasts should NEVER be done in isolation• Sum of the parts will ALWAYS be Greater than the

Whole = OVERSTOCK

• Forecasts should be done by drop/offer ANDrevise balance of season (use of Aii makes this relatively easy)

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Other Forecasting Factors

• Life of Item (> 1 Campaign/Offer)

• Review impact of creative changes• Size of picture• Page sequence change• Relationships to other items• Seasonality changes

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Item Selection Tips

• Set Thresholds• Margins (within category targets)• Sell Ratio• Return Rates

• Factor any Additional Costs• Carrying Costs• Special Prep or Shipping Costs

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Item Selections

• Relationships • Price Points (within Category)• Competition (External & Internal)• Ranking (A-B-C)

• Establish a Pro-Forma Item P&L(Sample included later in this presentation)

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Item Selections

• Consider Item Profitability• Weigh Cost of Overstock vs. placements and

minimums(e.g. Would it be worth to pay an up-charge to reduce

minimums?)• NEVER run an item – based solely on

inventory• Use sale “grids” only as a way to liquidate

overstock

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Additional “Advice”

• Mollo’s Rule of Forecasting• Negotiate lowest base price

• Have all merchandise costs been considered?• Additional prep charges• Margin check• Have all factors included?

• Set “trigger” thresholds

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Internet Forecasting

“Shopping online is like shopping in a department store with blinders on.”– Phil Terry, CEO, Creative Good

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Internet Forecasting

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Placing Buys73


Placing Item “Buys”

• Buy only AFTER item plans complete**– **Certain exceptions

• Consider the “horizon” of placements• Financial considerations for “planned overstock”

(caused by minimums)

• Consider a catalog “walk-thru” to adjust buys (+ / -)– Allows everyone – last chance for changes or

adjustments (fine-tuning)

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Open to Buy Plan

• The Master’s degree in Inventory Management • Process will require:

• Possible change in internal processes• Require effort to gather and regularly (e.g. weekly)

report on information• Willingness to be the “messenger”• Someone must be the inventory budget

“controller/banker”

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Open to Buy Plan

OTB Provides:• A “budget” for inventory spending• An “overstock” budget

Benefits:• Both coincide with marketing adjustments• “Projections” allow advance warning• Decisions can be made in advance, during season• Avoid spending “budget” twice• Management has the “control” tools

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Improving Inventory Coverage

• Better Planning & Forecasting allows increased “Just in Time” Buying

• Longer Range Planning - Identifies “Horizon” of Need• Plan by “Horizon/Season” rather than “Drop” (especially with web)• Inherent “Creative Merchant” hurdle – overcome with 80/20 rule

• Planning Reduces “hidden costs”• Impact on Creative Schedules• Some DC issues

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Improving Inventory Coverage

• Buys can be Scheduled– Based on “Horizons” and “Lead Times” – allows

greater flexibility for change– Allows forecasts to be modified to improve fill rates

(lower backorder costs, lower overstock, increased turns)

– Allows flexibility of removing items from future books where fill rates are at risk

– Allows early identification of potential overstock

• Risk/Rewards of Overbuying Can be Considered - In Advance

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Forecasting Summary

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Channels of Liquidation

Note: Sale vehicles: the objective is “sell-thru” NOT Fill Rates

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Item ProfitabilityReviewing Item P&L 81


Contribution Levels

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Item Profitability Model: Item Summary

Item # ABC123Description Sample Item

Cost 11.63 Inbound freight 3.0% 11.98

Retail 30.00 Unit Estimate 15000

Extended Cost 179.7 (k)Extended Retail 450.0 (k)

Cost % 39.9%Mark-Up % 60.1%

% of tot dmd $ -you might expect to cxl 9.0% 40.5 Total Returns as % of ships/ $(k) 11.8% 48.3

Net Sales ($k) 361.2 83


Item Profitability Model: COGS

Cost of Goods Sold standard cost 144.2

overstock (inv not sold) 10.0% 36.1 -Cost of overstock 3.0% 1.1

returns 3.0% 1.4other 0% 0.0

Gross Margin ($k) 214.4

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Item Profitability Model: Variable Expenses

Variable Cost Promotion 0.00

OR promotion (% of demand) 27.0% 121.5Cost of pick-pack-ship 10.0% 36.1

Miscellaneous CostsCost of Money/Borrowing 0.0% 0.0

Addn'l Overhead, warehouse space, etc. 0.0% 0.0

Contribution after Variable($k) 56.8

% net 15.7%

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Variable Cost Promotion 0.00

OR promotion (% of demand) 27.0% 121.5 Cost of pick-pack-ship 10.0% 36.1

Miscellaneous CostsCost of Money/Borrowing 0.0% 0.0

Addn'l Overhead, warehouse space, etc. 0.0% 0.0

Contribution after Variable($k) 56.8

% net 15.7%

Contribution after FixedFixed Exp 10.0% 36.1

Profit 20.7 % net 5.7%

Item Profitability Model: Fixed Expenses

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Communications87


Communication with Suppliers

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Communication with Suppliers

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Six Tips for Culture/Team Building

“Be Our Guest – Perfecting the art of Customer Service” by Disney Institute, 2001

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Several Rules of Business

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Thank You !!

•Questions ?

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George MolloGJM Associates, Inc.www.gjmassociates.com(845) [email protected]

(**PDF copies are available on website)

Documents

Fundamentals of Inventory Management NCOF 2011 … to substantiate an organization’s objectives ... • Are there limits? – False conclusions ... Fundamentals of Inventory Management