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CHAPTER 13: BUYING SYSTEMS ANNOTATED OUTLINE INSTRUCTOR NOTES

I. Introduction

• The actual management of a retail inventory on a daily basis is quite complex. Retailers employ computer-based information and planning support systems to assist buyers in this challenging management task. These systems help buyers, planner, and assorters determine when and how much to buy and what adjustments might be needed in the pricing and allocation of merchandise to specific stores.

• Retailers use two distinct types of buying systems, one for staple merchandise categories and the other for fashion merchandise categories.

• Some retailers have developed their own merchandise planning systems while others use software systems developed by companies such as Marketmax, Retek, JDA and GERS.

• In some retail firms these merchandise planning systems are part of the firm’s enterprise resource planning (ERP) system, which integrates merchandise planning with systems for managing supply chains and other business activities.

See PPT 13-3

I. Staple Merchandise Management Systems

• Staple merchandise buying systems are used for merchandise that follows a predictable order-receipt-order cycle. Most merchandise fits this criterion.

• Staple merchandise planning systems manage inventory at the level of the SKU.

• Inventory that goes up and down due to the replenishment process is called cycle stock, or base stock. The retailer would like to reduce the base stock inventory to keep its inventory investment low.

• Sales of the SKU and receipts of orders from

PPT 13-4, 13-5, and 13-6 1 illustrate the function of a staple merchandise management system.

Ask students for examples to review typical staple merchandise categories.

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the vendor cannot be predicted with perfect accuracy. Therefore, the retailer has to carry backup stock, also known as safety stock or buffer stock.

• Several factors determine the level of backup stock required: (1) the product availability the retailer wants to provide, (2) fluctuation in demand (greater fluctuation requires more backup stock), (3) the lead time (amount of time between recognition that an order needs to be placed and the point at which the merchandise arrives in the store and ready for sale) from the vendor, (4) fluctuations in lead time (retailers using collaborative supply chain management systems typically require their vendors to deliver within a very narrow window to reduce fluctuations in lead time), and (5) the vendor’s product availability.

• Staple merchandise planning systems provide the information neeeded to determine how much to order and when to place orders for SKUs. These systems assist buyers by performing three functions: (1) monitoring and measuring current SKU sales, (2) forecasting future SKU demand, and (3) developing ordering decision rules for optimum restocking.

Factors determining backup stock are shown in 13-7.

See PPT 13-8, 13-9, and 13-10

A. The Inventory Management Report

• The inventory management report provides information on sales velocity, inventory availability, the amount on order, inventory turnover, sales forecast, and, most important, the quantity that should be ordered for each SKU.

• The combination of having a prespecified schedule based on the trade-off between inventory carrying and ordering costs, and the flexiblity to react to demand fluctions, helps to ensure a profitable ordering strategy.

PPT 13-11 shows a retailer’s sample inventory management report.

1. Order point

• The order point is the amount of inventory below which the quantity available should

See PPT 13-12 and 13-13

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not go or the item will be out of stock before the next shipment arrives.

Order point =

Sales/Day x (Lead time + Review time) + Backup stock

• This number tells the buyer that when the inventory level drops to this point, additional merchandise should be ordered.

• Lead time is the time between recognition that an order needs to be placed and the receipt of merchandise in stores ready for sale.

• Review time is the maximum time between reviews of the SKU.

See example on PPT 13-14

2. Order Quantity

• When inventory reaches the order point, the buyer needs to order enough units so the stock isn’t depleted and sales dip into backup stock before the next order arrives. This order quantity is the difference between the quantity available and the order point.

• Using this system to calculate order points and order quantities for staple merchandise SKUs, orders can be transmitted directly to vendors using EDI without needing to involve the buyer.

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II. Fashion Merchandise Management System

• The merchandise budget plan specifies the planned inventory investment in dollars in a fashion merchandise category over time. The plan specifies how much money should be spent each month to support sales and achieve turnover and GMROI objectives.

• The buyer needs to plan how much merchandise should be delivered in each month to achieve the financial goals for the period.

• The "Monthly Additions to Stock” tells the buyer how much merchandise in retail dollars he or she needs to have arriving in the stores and available for sales each month for the retailer’s financial goals to be met.

• The “Monthly Additions to Stock” is derived by the following method.

See PPT 13-15, PPT 13-16, and PPT 13-17

A. Monthly Sales Percent Distribution To Season (Line 1)

• Line 1 of the plan projects what percentage of the total sales is expected to be sold in each month.

• The percentage of total sales in a particular month doesn’t vary appreciably from year to year, so historical records are used to derive monthly percentages.

• The buyer must include special sales that did not occur in the past in the percent distribution of sales by month.

Also called a seasonality index. Most merchandise has some seasonality. Even toilet paper -- fancy styles sell better during the holiday season when people have lots of guests in their houses. Can derive using a weighted average from past years, then adjusting for current trends

See PPT 13-18.

B. Monthly Sales (Line 2)

• Monthly sales equal the forecast total sales for the six month period (last column) multiplied by each sales percentage by month (line 1).

• Monthly sales for April = $27,300 (i.e., $130,000 X 21%)

See PPT 13-19

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C. Monthly Reductions Percent Distribution to Season (Line 3)

• To have enough merchandise every month to support the monthly sales forecast, the buyer must consider factors that reduce the inventory level. Apart from sales, the value of the inventory is also reduced by markdowns, shrinkages, and discounts to employees.

• Markdowns can be forecast fairly accurately from historical records.

• Cost of the employee discount is tied fairly closely to the sales level and number of employees and can be forecast fairly accurately from historical records.

• Shrinkage is caused by shoplifting by employees or customers, by merchandise being misplaced or damaged, or by poor bookkeeping. The buyer measures shrinkage by taking the difference between (1) the inventory's recorded value based on merchandise bought and received and (2) physical inventory in stores and distribution centers.

• Shrinkage varies by department and season and typically also varies directly with sales.

Reductions are often difficult for students to understand. Tell them that they work in the same direction as sales. In other words, if you put something on sale or if something is stolen, it reduces the value of the inventory at retail. Retailers have to not only buy enough to support their sales; they also have to buy enough to support their reductions. If they don't, consider reductions, they will run out of stock by the amount of merchandise that is put on sale or stolen.

See PPT 13-20

See PPT 13-21

D. Monthly Reductions (Line 4)

• Monthly reductions are calculated the same way monthly sales are calculated. Total reductions are multiplied by each percentage in line 3.

• April reductions = $6,600 (i.e., $16,500 X 40%).

See PPT 13-22

E. Beginning of Month Stock-to-Sales Ratio (Line 5)

• The stock-to-sales ratio specifies the amount of inventory that should be on hand at the beginning of the month to support the sales forecast and maintain the inventory

Like % distribution of sales by month, monthly stock-to-sales ratios fluctuate by month, but in opposite direction of sales. Bathing suits start arriving in March, but sales don’t take off until May, so in May, stock and sales are both increasing, but sales are increasing faster, so stock-to-sales ratio decreases. But in July, stores still have inventory, but sales drop off quickly,

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turnover objective. resulting in an increase in stock-to-sales ratio.

See PPT 13-23

1. Step 1: Calculate sales-to-stock ratio.

• The GMROI is broken down into gross margin and sales-to-stock ratio.

• GMROI = Gross margin % X Sales-to- stock ratio

2. Step 2: Convert the sales-to-stock ratio to inventory turnover.

As stated in chapter 12,

Inventory turnover = Sales-to-stock ratio X (1 - Gross margin %/100)

• This adjustment is necessary since the sales-to-stock ratio defines sales at retail and inventory at cost, whereas inventory turnover either defines both sales and inventory at retail or at cost.

3. Step 3: Calculate average stock-to- sales ratio.

• Average stock-to-sales ratio = 6 months ÷ Inventory turnover

• As with inventory turnover, both the numerator and denominator can be either at cost or retail.

• It can be easily confused with the sales-to-stock ratio, but one isn’t the inverse of the other.

4. Step 4: Calculate monthly stock- to-sales ratios.

• The monthly stock-to-sales ratios in line 5 must average the BOM stock-to-sales ratio calculated above to achieve the planned inventory turnover.

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• Generally, monthly stock-to-sales ratios vary in the opposite direction of sales. That is, in months when sales are larger, stock-to-sales ratios are smaller, and vice versa.

• The merchandise buyer must consider the seasonal pattern for a classification in determining the monthly stock-to-sales ratios.

• When doing a merchandise budget plan for a classification that has accumulated history, the buyer examines previous stock-to-sales ratios. Then the buyer makes minor corrections to adjust for previous imbalance in inventory levels.

• Adjustments are also made for changes in the current environment, such as a promotion that has never been done before.

• Caution: Monthly stock-to-sales ratios don’t change by the same percentage as the percent distribution of sales by month is changing. In months when sales increase, stock-to-sales ratios decrease, but at a slower rate.

F. BOM (Beginning of Month) Stock (Line 6)

• The amount of inventory planned for the beginning of month (BOM) equals

Monthly sales (line 2) X BOM stock-to-sales ratio (line 5).

Sales X (stock/sales) = stock. That is, sales drops out of the equation.

See PPT 13-24

G. EOM (End of Month) Stock (Line 7)

• The BOM stock from the current month is the same as the EOM (end of month) stock in the previous month. So, to derive line 7, simply move BOM stock in line 6 down one box and to the left.

When a retailer closes for business at the end of the month, the inventory should be the same the next morning when the store opens at the beginning of the month.

See PPT 13-25

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H. Monthly Additions to Stock (line 8)

• The monthly additions to stock is the amount to be ordered for delivery in each month, given turnover and sales objectives.

• Additions to stock = Sales (line 2) + Reductions (line 4) + EOM inventory (line 7) - BOM inventory (line 6)

• The difference between EOM stock if nothing is purchased (BOM stock - sales - reductions) and the forecast EOM stock is the additions to stock.

Emphasize: Retailer should purchases amounts indicated in line 8 which is based on sales forecasts, inventory turnover goals, and historical sales patterns.

See PPT 13-26

I. Evaluating the Merchandise Budget Plan

• GMROI, inventory turnover, and the sales forecast are used for both planning and control. The previous sections have described how they all fit together in planning the merchandise budget.

• After the selling season, it is important to determine how well the classification actually performed compared to the plan for control purposes.

• No performance evaluation should be based on any one of these measures, however. Several additional questions must be answered to evaluate the buyer's performance.

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III. Open-to-Buy

• The open-to-buy system starts after the merchandise is purchased using the merchandise budget plan or staple merchandising system.

• The open-to-buy system keeps track of merchandise flows while they are occurring. Specifically, open-to-buy system record how much is spent each month, and therefore how much is left to spend.

• For the merchandise budget plan to be successful (i.e., meet the sales, inventory turnover, and GMROI goals for a category), the buyer attempts to buy merchandise in quantities and with delivery dates such that the actual EOM (end of month) stock for a month will be the same as the projected or forecasted EOM stock.

See PPT 13-27

Now that buyer knows how much to spend in each month (based on merchandise budget plan), buyer must keep track of spending using open-to-buy.

A. Calculating Open-to-buy for the Current Period

• Buyers develop plans indicating how much inventory for the merchandise category will be available at the end of the month.

• These plans might be inaccurate. Shipments might not arrive on time, sales might be greater than expected, and/or reductions might be less than expected.

• The open-to-buy is the difference between the projected EOM inventory and the planned EOM inventory.

• Open-to-buy for a month =

Actual EOM planned inventory – Projected EOM inventory

• The EOM planned inventory is taken from the merchandise budget plan, and the EOM projected inventory is calculated as follows:

• Projected EOM inventory =

actual BOM inventory + monthly additions

See PPT 13-28

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actual (received new merchandise) + on order (merchandise to be delivered) – sales plan (merchandise sold) – monthly reductions plan.

• Thus the projected EOM inventory will be less than the planned EOM inventory if sales or reductions are greater than the merchandise budget plan or less merchandise is delivered than planned.

IV. Allocating Merchandise to Stores

• After developing a plan for managing merchandise inventory in a category, the next step in the merchandise management process is to allocate the merchandise purchased and received to the retailer’s stores.

• Many retailers have a created a position called either “allocators” or “planners” to specialize in making store allocation decisions.

• Allocating merchandise to stores involves three decisions: (1) how much merchandise to allocate to each store, (2) what type of merchandise to allocate, and (3) when to allocate the merchandise to different stores.

See PPT 13-29

A. Amount of Merchandise to be Allocated to Each Store

• One approach for allocating the amount of merchandise to stores is to make the allocation proportional to the forecasted sales for each store.

• In other words, if a store represents 10 percent of a merchandise category’s sales, that store is allocated 10 percent of the merchandise inventory.

See PPT 13-30

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B. Type of Merchandise Allocated to Stores

• In addition to classifying stores on the basis of their size and sales volume, retailers classify stores according to the characteristics of the stores’ trading area.

• Store trade area geodemographics are used to develop merchandise assortments for specific stores.

See PPT 13-31, 13-32, and 13-33 for illustrations of merchandise allocation decisions.

C. Timing of Merchandise Allocation to Stores

• Differences in the timing of category purchases across stores also need to be considered.

• Buyers need to recognize regional differences and arrange for merchandise to be shipped to the appropriate regions when customers are ready to buy to increase inventory turnover in the category.

V. Analyze Merchandise Performance

• The next step in the merchandise management process is to analyze the performance of the process and make adjustments as necessary.

• Three procedures are used for analyzing merchandise management performance.

• The first, known as ABC analysis, is a method of rank-ordering merchandise to make inventory stocking decisions.

• The second procedure, a sell-through analysis, compares actual and planned sales to determine whether early markdowns are required or whether more merchandise is needed to satisfy demand.

• The third approach is a method for evaluating vendors using the multiattribute model.

See PPT 13-34

A. Sell-Through Analysis

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• A sell-through analysis is a comparison between actual and planned sales to determine whether early markdowns are required or whether more merchandise is needed to satisfy demand.

• The decision depends on experience with the merchandise in the past, whether the merchandise is scheduled to be featured in advertising, whether the vendor can reduce the buyer's risk by providing markdown money, and other merchandising issues.

See PPT 13-35

Ask students what action should be taken with the white and blue silk blouses Exhibit in PPT 13-31.

B. ABC Analysis

• ABC analysis identifies the performance of individual SKUs in the assortment plan.

• It is used to determine what SKUs should be in the plan and how much backup stock and resulting produce availability is provided for each SKU in the plan.

• ABC uses the general 80-20 principle that implies that approximately 80 percent of a retailer's sales or profits come from 20 percent of the products.

• The first step in the ABC analysis is to rank-order SKUs using one or more performance measures.

• Measures commonly used in ABC analysis are sales dollars, sales in units, gross margin, and GMROI (gross margin return on investment).

• The next step is to classify the items. Then, on the basis of the classification, determine whether to maintain the item in the assortment plan and if so, what level of product availability to offer.

• A items account for 5 percent of items and represent 70 percent of sales. These items should never be out of stock.

• B items represent 10 percent of the SKUs and an additional 20 percent of sales. The store should pay close attention to the B

See PPT 13-36 and 13-37

Ask students to think of other instances where the 80-20 principle seems to work, e.g., 80% of a store's sales are generated by 20% of its sales force or 20% of its space.

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items, but it may run out of some SKUs in the B category, since it's not carrying the same amount of backup stock as for A items.

• C items account for 65% of SKUs but contribute only 10 percent of sales.

• There are also D items. These items had no sales whatsoever during the past season, having become out of date or shopworn. These represent excess inventory. Most retailers with excess merchandise should have a simple decision strategy: Mark it down or give it away, but get red of it.

C. Multiattribute Method

• The multiattribute analysis method for evaluating vendors uses a weighted average score for each vendor.

• A buyer can evaluate vendors by using five steps.

1. Develop a list of issues to consider in the decision. A balance should be made between too short or too comprehensive a list of issues.

2. Importance weights for each issue should be determined by the buyer/planner in conjunction with the merchandise manager. A scale of 1 – 10, with 1 being least important and 10 being most important, can be used.

3. Make judgments about each individual brand's performance on each issue.

4. Combine the importance and performance scores by multiplying the importance for each issue by the performance for each brand or its vendor.

5. Determine the vendors’ overall rating by summing the product for each brand for all issues to compute an overall rating.

See PPT 13-38 through 13-41

Students may find this a little too “academic.” To make it a little more palatable, ask them to consider how difficult it was to choose a college. Doing a multiattribute model may have made their ultimate choice seem more rational. They might argue that the ratings and the importance weights are arbitrary. But they really aren’t. If you buy into the weights and the ratings, then you have to buy into the result.

VI. Summary

Appendix 13A: Retail Inventory Method

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(RIM)

• The first objective is to maintain a perpetual or book inventory in terms of retail dollar amounts.

• The second objective is to maintain records that make it possible to determine the cost value of the inventory at any time without taking a physical inventory.

See PPT 13-42

A. The Problem

• Retailers generally think of their inventory at retail price levels, rather than at cost. They take their initial markups, markdowns, and so forth as a percentage of retail.

• The problem is that when retailers design their financial plans, evaluate performance, and prepare financial statements, they need to know the cost value of their inventory.

See PPT 13-43

B. Advantages of RIM

• RIM has five advantages over a system of evaluating inventory at cost:

• The retailer doesn't have to "cost each item.”

• RIM follows the accepted accounting practice of valuing assets at cost or market, whichever is lower.

• As a by-product of RIM, the amounts and percentages of initial markups, additional markups, markdowns, and shrinkage can be identified.

• RIM is useful for determining shrinkage.

• The book inventory determined by RIM can be used in an insurance claim in the case of a loss such as a fire.

See PPT 13-44 and 13-45

C. Disadvantages of RIM

• One disadvantage of RIM is based on the system’s use of average markup. When markup percentages change substantially

See PPT 13-46

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during a period, or when inventory on hand is different from total goods, the cost figure could be distorted.

• Another disadvantage is that the record-keeping process involved in RIM is burdensome.

D. Steps in RIM See PPT 13-47 through 13-43 for an illustration of the steps in RIM process.

1. Calculate Total Goods Handled at Cost and Retail

• a. Record beginning inventory at cost and at retail.

• b. Calculate net purchases by recording gross purchases and adjusting for returned merchandise to vendor.

• c. Calculate net additional markups by adjusting gross additional markups by any additional markup cancellations.

• d. Record transportation expenses.

• e. Calculate net transfers by recording the amount of transfers in and out.

• f. The sum is the total goods handled.

2. Calculate Retail Reductions

• Reductions are the transactions that reduce the value of inventory at retail (except additional markup cancellations which were included as part of the total goods handled).

• a. Record net sales.

• b. Calculate markdowns.

• c. Record discounts to employees and customers.

• d. Record estimated shrinkage.

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• e. The sum is the total reductions.

3. Calculate the Cumulative Markup and Cost Multiplier

• The cumulative markup is the average percentage markup for the period. It is calculated the same way the markup for an item is calculated:

Cumulative markup = Total retail - Total cost Total retail

• The cumulative markup can be used as a comparison against the planned initial markup.

• The cost multiplier is similar to the cost complement.

The cost multiplier = (100% - Cumulative markup%)

or = Total cost Total retail

4. Determine Ending Book Inventory at Cost and Retail

• ending book inventory at retail = total goods handled at retail - total reductions.

• The ending book inventory at cost is determined the same way that retail has been changed to cost in other situations:

• Ending book inventory at retail = ending book inventory at retail X cost multiplier

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ANSWERS TO DISCUSSION QUESTIONS AND ANSWERS

1. Inventory shrinkage can be a problem for many retailers. How does the merchandise budget planning process account for inventory shrinkage?

Shrinkage is caused by shoplifting by employees and/or customers, by merchandise being misplaced or damaged, or by poor bookkeeping. The merchandise budget plan measures shrinkage in monthly reductions along with markdowns and discounts. Reductions reduce the value of the inventory in the same way that a sale does. If a retailer wants to have enough merchandise to satisfy the sales forecast and inventory turnover goals, then the retailer needs to buy enough to cover reductions. Accounting for shrinkage then, is a very important part of the planning that is involved in the merchandise budget plan.

2. Using the following information, calculate additions to stock:

Sales $24,000EOM stock $90,000BOM stock $80,000

• Planned purchases = EOM + Sales - BOM Planned purchases

= 90,000 + 24,000 - 80,000

• Planned purchases = 34,000

3. Using the following information, calculate the average BOM stock-to-sales ratio for a six-month merchandise budget plan:

GMROI 150%

Gross Margin 40%

• GMROI = GM% * Stock-to-Sales

150% = .40 X Stock-to-Sales

= 3.75 Stock-to-Sales

• Inventory Turnover = 3.75 X (1-. 40)

• Inventory Turnover = 2.25

• Stock-to-Sales = 6months / 2.25

• Stock-to-Sales = 2.66

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4. Today is July 19. A buyer is attempting to assess his current open-to-buy given the following information:

Actual BOM stock $50,000Monthly additions actual $25,000Merchandise on order to be delivered $10,000Planned monthly sales Planned reductions

$30,000$5,000

Planned EOM stock $65,000

What is the open-to-buy on July 19? What does this number mean to you?

Projected EOM stock = BOM stock $50,000

+Monthly additions actual +$25,000

+Merchandise on order +$10,000

-Planned Sales -$30,000

-Planned Reductions -$5,000

Projected EOM Stock = $50,000

Open-to-Buy = Planned EOM stock – Projected EOM stock

Open-to-Buy = $65,000 - $50,000

Open-to-Buy = $15,000

* The buyer has $15,000 left to spend for merchandise for delivery in July.

5. Now it is July 31, and we need to calculate the open-to-buy for August given the following information:

Planned monthly sales $20,000Monthly additions actual $40,000Planned markdowns $5,000Projected BOM stock $50,000Planned EOM stock $30,000

Calculate the open-to-buy and explain what the number means to you.

Projected EOM stock = Projected BOM stock $50,000

+Monthly additions actual +$40,000

-Planned Sales -$20,000

-Planned Markdowns -$5,000

Projected EOM Stock = $65,000

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Open-to-Buy = Planned EOM stock – Projected EOM stock

Open-to-Buy = $30,000 - $65,000

Open-to-Buy = (-$35,000)

* The buyer has purchased $35,000 more than he/she had planned.

6. Typically, August school supply sales are relatively low. In September, sales increase tremendously. How does the September stock-to-sales ratio differ from the August ratio?

As sales increase the stock/sales ratio should decrease, since a proportionate increase in inventory is not needed to support the increase in sales. The decrease is not, however inversely proportional to the increase in sales because extreme increases in inventory is not needed to support higher levels of sales.

7. Using the 80-20 principle, how can a retailer make certain it has enough inventory of fast-selling merchandise and a minimal amount of slow-selling merchandise?

Retailers should rank products by the 80-20 principle, which maintains that 80% of a retailer’s sales or profits come from 20% of the products. This ranking system is known as the ABC Analysis. Essentially, the retailer should divide the inventory into “A”, “B”, or “C” categories depending upon the importance of each item. The “A” category items are those that are most important. The retailer should make sure that the store has these items all the time. The “B” category items are important but the retailer can afford to be out of these items once in a while. The “C” category items are not that important and the retailer should try to only special order these items for specific customer orders.

8. What is the order point and how many units should be reordered if a food retailer has an item with a 7-day lead-time, 10-day review time, and daily demand of 8 units? Say 65 units are on hand and the retailer must maintain a backup stock of 20 units to maintain a 95 percent service level? Order point = daily demand (lead time + review period) + backup stock Order point = 8 (7 + 10) + 20 Order point = 156 Units to be ordered = Order point - units on hand Units to be ordered = 156 - 65 Units to be ordered = 91

9. A buyer at a sporting goods store in Denver receives a shipment of 400 ski parkas on October 1 and expects to sell out by 31. On November 1, the buyer still has 375 parkas left. What issues should the buyer consider in evaluating the selling season’s progress?

Using a sell-through analysis, if the selling season is supposed to be four months, the buyer should expect to sell about 100 units in the first month. Before deciding whether or not the merchandise is really selling significantly slower than it should be, the buyer should consider any environmental factors such as a particularly warm autumn. If the weather is normal, the buyer should take drastic action, such as marking down the parkas or promoting them. If the markdown strategy is chosen, the buyer should try to obtain markdown money from the vendor.

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10. If you have a stock-to-sales ratio of 2, how many months of supply do you have? How many weeks of supply?

A stock-to-sales ratio of 2 means we have two months of inventory, or approximately 60 days of stock on hand at the beginning of the month. Weeks of supply is simply the months of supply times four weeks. Therefore, the stock-to-sales ratio of 2 implies 8 weeks of supply.

11. A buyer is trying to decide from which vendor to buy a certain item. Using the following information, determine from which vendor the buyer should buy.

VENDOR PERFORMANCE Issues Importance

Weight Vendor A Vendor B

Reputation for collaboration 8 9 8 Service 7 8 7 Meets delivery dates 9 7 8 Merchandise quality 7 8 4 Gross margin 6 4 8 Brand name recognition 5 7 5 Promotional assistance 3 8 8

Vendor A Vendor B 8 x 9= 72 8 x 8 = 64

7 x 8 = 56 7 x 7 = 49 9 x 7 = 63 9 x 8 = 72 7 x 8 = 56 7 x 4 = 28 6 x 4 = 24 6 x 8 = 48 5 x 7 = 35 5 x 5 = 25 3 x 8 = 24 3 x 8 = 24

330 310

Therefore the buyer should choose Vendor A.

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ADDITIONAL DISCUSSION QUESTIONS AND PROBLEMS

1. A retailer is expecting a good month and is adjusting the sales forecast upward by $750. Using the following information, calculate the March open-to-buy:

Planned purchases (March) $32,000Monthly additions actual 21,000Merchandise on order (March) 8,000Open-to-buy unused (February) 2,000

Open-to-buy = Planned purchases – Monthly additions actual -Merchandise on order + Sales adjustment + Unused open-to-buy

Open-to-buy = 32,000 - 21,000 - 8,000 + 2,000 + 750 = 5,750

2. What is the difference between open-to-buy and merchandise budget planning?

Open-to-buy keeps track of how much you’ve spent—the “buyer’s” checkbook.” It is a simple record-keeping function. Merchandise budget planning, on the other hand, is driven by two factors: sales forecast and inventory turnover.

3. The Sports Shop has beginning inventory of $12,000 and planned ending inventory of $13,400. Planned sales for the period are $5,800. Calculate the open-to-buy for the month.

For this problem, merchandise requirements consist only of planned ending inventory (beginning inventory for next month) and sales. So we can determine open-to-buy as follows:

Merchandise requirements:

Planned ending inventory $13,400 Planned sales 5,800Merchandise requirements 19,200 Merchandise available: Beginning inventory 12,000 Open-to-buy $7,200

4. A buyer notices that she is constantly out of stock on Eveready AAA Batteries. She is using

an SKU based inventory system similar to INFOREN. How should she adjust the alpha in her exponential smoothing formula?

The reason that she is constantly out of stock is because the exponential smoothing formula is not reacting quickly enough to changes in demand. To correct this situation the buyer should experiment with increasing alpha.

5. What is the reorder point, and how many units should be reordered if a retailer has an item that has a lead time of 10 days, a review time of 15 days, daily demand of 18 units, and there

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are 82 units on hand and the retailer must maintain a backup stock of 27 units to maintain a 95% service level?

Reorder point = Daily demand (Lead time + Review period) + Backup stock

Reorder point = 18 (10 + 15) + 27

Reorder point = (18 x 25) + 27

Reorder point = 450 + 27

Reorder point = 477

Units to be ordered = Reorder point - units on hand

Units to be ordered = 477 - 82

Units to be ordered = 395

ANCILLARY LECTURES AND EXERCISES

EXERCISE # 13-1: JENNING'S DEPARTMENT STORE: THE PREPARATION OF A MERCHANDISE BUDGET PLAN

------------------------------------------------- Instructor’s Note: This is an exercise in which students have the opportunity to prepare a merchandise budget plan. This exercise can be given as a homework assignment or may be used as a class exercise. Instructors might want to use this lecture as a stimulus to a class discussion on the topic.

-------------------------------------------------

The situation

For years, Jenning's has catered to the middle and upper income groups by consistently carrying products of extremely high quality.

Last year's sales volume was $45,000,000.

In the recent past, however Jenning's has been losing market share to competition in the area.

To counteract this problem, Jenning's is planning to enforce a strong promotional advertising campaign which will increase sales by 5% for the coming year.

Department 007 happens to be the most profitable department in the store, maintaining a Gross Margin of 55%. Its basic merchandise is sporting goods and equipment.

Last year's sales for this department reached $312,000 for the July through December season.

The highest sales period in the early football season in September when much sports equipment is sold for high school and college football teams.

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By month the percentage of annual sales for Department 007 within this 6 month period has been distributed as follows:

July Aug. Sept. Oct. Nov. Dec. 1977 5.4 6.1 11.3 8.6 7.4 9.1 1978 5.2 6.0 11.5 8.0 7.8 8.9 1979 4.2 5.9 11.4 8.2 7.9 9.2 1980 5.3 6.0 11.4 8.3 7.9 9.0

For the first time, an "After-Thanksgiving" sale has been planned in an attempt to counter-balance the slackened sales period that inevitably follows in the later months.

The department manager has chosen to include basketball and hockey equipment for the sale along with the late summer and early fall merchandise.

The manager anticipates that this event will increase December's percentage of annual sales to 25% above what it would be without the sale.

Top management has approved the proposal, and insists that the department maintains a Gross Margin Return on Investment of 44%.

The GMROI was based on the target Return on Owners Equity and the current Strategic Profit Model.

Forecasted ending stock level is $58,000.

Additional information is available on the historical stock-sales ratio for this type of department figured on the basis of BOM inventories.

This information is taken from a similar department in another store that happens to have a lower inventory turnover.

July Aug. Sept. Oct. Nov. Dec 2.4 2.1 1.9 2.5 3.0 1.9

This is the information that the manager of Department 007 has available for the preparation of this merchandise plan.

On the basis of this information, prepare a month by month merchandise plan for this 6 month season.

Give reasoning for your judgment.

The Solution

The solution to this case begins with forecasting next year's sales for the department.

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Step 1. Sales Forecast for Dept. 007: $312,000 x 1.05% = $327,600

The forecast is not complete because we must account for the expected increase in sales in December, due to the planned sale.

In order to do this, calculate the originally planned percentage distribution of annual sales for December and adjust accordingly from that figure.

Use a weighted average for this purpose.

The weights will be as follows: 1988=0.1, 1989=0.2, 1990=0.3, and 1991=0.4.

Step 2 December's original percentage of annual sales: 9.1(0.1) + 8.9(0.2) + 9.2(0.3) +9.0(0.4) = 9.05% Step 3 December's sales in dollars: $327,600 x 9.05% = $29,648 Step 4 Management expects a 25% increase in December's sales: $29,648 x 25% = $7,412 Step 5 The overall sales forecast must be increased by this amount: $327,600 + 7,412 = 335,012 or

approx. 335,000.

Next, we wish to do all the calculations necessary to complete the top portion of the Merchandise Budget worksheet.

In order to do this we must first determine the gross margin for the department in dollars.

Step 6. Gross margin for Dept. 007: $335,000 x 55% = $184,250

We then use the formula given on the worksheet and the figures we have already calculated (along with those given) to determine the Inventory Cost.

Step 7 Calculate inventory cost: Planned GMROI = (Gross margin ÷ Net sales) x (Net sales ÷ Inventory cost). 244% = (184,250 ÷ 335,000) x (335,000 ÷ Inventory cost)

Inventory cost) Inventory cost = (184,250 ÷ 2.44) Inventory cost = $75,512

Step 8. Use formula given to determine inventory turnover: Inventory turnover =

(Net sales ÷ Inventory cost) x (100% - Gross margin)

Inventory turnover = (335,000 ÷ 75,512) x (100% - 55%) Inventory turnover = 2

The formula for the Beginning of Month (B.O.M.) Stock-to-Sales Ratio must be altered to reflect the six month schedule of this particular case.

Step 9 Use formula to determine the B.O.M. Stock-to-Sales Ratio: B.O.M. Stock-to sales-ratio = # of months ÷ Inventory turnover

B.O.M. Stock-to-sales ratio = 6 ÷ 2 B.O.M. Stock-to-sales ratio = 3

Next, we determine the percentage of annual sales for the rest of the months in a manner similar to the one used to determine this percentage for December, the weighted average.

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Step 10 July 5.4(0.1) + 5.2(0.2) + 5.2(0.3) + 5.3(0.4) = 5.26 Aug 6.1(0.1) + 6.0(0.2) + 5.9(0.3) + 6.0(0.4) = 5.98 Sept 11.3(0.1) + 11.5(0.2) + 11.4(0.3) + 11.4(0.4) = 11.41 Oct 8.6(0.1) + 8.0(0.2) + 8.2(0.3) + 8.3(0.4) = 8.24 Nov 7.4(0.1) + 7.8(0.2) + 7.9(0.3) + 7.9(0.4) = 7.83 11.31 50.03

Now set up the following ratio to adjust the monthly percentage of sales so they will equal 100%:

Step 11 50.03 ÷ 100 = current % ÷ new % 50.03 ÷ 100 = 5.26 ÷ new % New % = 10.51

Therefore: July = 10.51%, August = 11.95%, September = 22.81%, October = 16.47%, November = 15.65%, and December = 22.61%.

Multiplying these percentages by the total sales, we obtain the monthly dollar sales:

Step 12 $335,000 x 10.51% = $35,208

Therefore: July = $35,208, August = $40,033, September = $76,413, October = $55,175, November = $52,427, and December = $75,744.

In this case, reductions are not a consideration, so ignore them.

Next, determine Beginning of Month Stock-to-Sales Ratios (BOM Stock/Sales).

To do this, set up another ratio to determine the figures needed.

First, determine the average for the stock-to-sales ratios from the other store that is considered to be similar to Jenning's.

Step 13. Average stock-to-sales ratio = (2.4 + 2.1 + 1.9 + 2.5 + 3.0 + 1.9) ÷ 6 Average stock-to-sales ratio = 2.3

Next, set up the final ratio:

Step 14 (Other store average ÷ Jenning’s average) = (Other store monthly ÷ Jenning’s monthly). (2.3 ÷ 3.0) = (2.4 ÷ July) July = 3.13

Therefore: July = 3.13 -> 3.23, August = 2.74 -> 2.84, September = 2.48 -> 2.58, October = 3.26 -> 3.36, November = 3.91 -> 4.01, and December = 2.48 -> 1.98.*

Note* - Since December's sales were increased, its stock-to-sales ratio must decrease. It may be calculated to be 1.98, a decrease of 0.5 (which was distributed evenly to insure that the average remained 3.0).

Beginning of Month Stock is determined by multiplying monthly sales by its respective B.O.M. Stock-to-Sales Ratio.

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Then, End of Month Stock is equal to the Beginning of Month Stock for the following month (i.e. EOM January = BOM February).

Monthly Additions to Stock is then computed by adding Monthly Sales to EOM Stock and subtracting BOM Stock.

EXERCISE # 13-2: DETERMING ENDING INVENTORY USING THE RETAIL INVENTORY METHOD

Instructor’s Note: This is an exercise in which students have the opportunity to determine the ending inventory at retail and cost using the retail inventory method of accounting. This exercise can be given as a homework assignment or may be used as a class exercise. Instructors might want to use this lecture as a stimulus to a class discussion on the topic.

The Situation

Use the retail inventory method of accounting to determine the ending inventory at retail and cost.

COST RETAILBeginning Inventory $20,000 $70,000Gross Purchases 144,000 230,000- Purchase Returns & Allowances 6,000 9,400Transfers In 2,000 3,200Transfers Out 3,000 4,800Freight In 3,000Additional Markup 1,400Additional Markup Cancellation 400Gross Sales 220,000Customer Return & Allowances 20,000Gross Markdowns 9,000Markdown Cancellations 2,000Employee Discounts 1,000Cash Discounts on Purchases 4,000Workroom Costs 2,000Operating Expenses 60,000

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The Solution

RETAIL INVENTORY METHOD

COST RETAIL Beginning inventory $20,000 $70,000 Purchases 144,000 230,000 - Returns (6,000) (11,000) Net Purchases 138,000 219,000 Transfer In 2,000 3,200 - Transfer Out (3,000) (4,800) Net Transfers (1000) (1600)Freight in 3,000 Markups 1,400 Markup Cancellations (400) Net Markups 1,000 Total Goods Handled 160,000 290,000 Gross Sales 220,000 - Consumer Returns & Allowanc (20,000) Net Sales 200,000 Markdowns 9,000 - Markdown Cancellation (2,000) Net Markdown 7,000 Employee Discounts 1,000 Total Reductions 208,000

Cumulative Markon = (total retail - total cost) ÷ total retail:

($290,000 - $160,000) ÷ $290,000 = 44.8%

The Cost Multiplier = cumulative markon (100% - cumulative markon %) = 55.2%

Ending book inventory at retail = total goods handled at retail - total reductions:

$290,000 - $208,000 = $82,000

Ending book inventory at cost = ending book inventory at retail x cost multiplier:

$82,000 x 55.2% = $45,264

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Hints on Retail Method of Inventory

• Think of total goods handled as total “ins,” and reductions as total “outs.” • So, total “ins” minus total “outs” equal ending inventory. • The “ins” are basically what you start with (beginning inventory) , plus what you purchase, plus or

minus adjustments • If it is at both cost and retail, it is always part of total goods handled. • Reductions are only at retail. • Think of the cumulative markon as similar to the maintain markup or the gross margin, but it is over

the entire inventory rather than just one item. • It can even be called a “kinda” gross margin because it is calculated the same way. • The cost multiplier is very similar to the cost complement. • It can even be called a “kinda” cost complement because it is calculated from the cumulative markon

in the same way that the cost complement is calculated from the gross margin. • The ending book inventory at retail is simply the total “ins” minus the total “outs.” • In other words, it is the inventory you start with, plus what you purchase, plus or minus adjustments,

minus all the reductions to your inventory like sales and markdowns. • Getting the ending book inventory at cost from the ending book inventory at retail is similar to getting

from retail to cost—just multiply by the cost multiplier (the “kinda” cost complement).

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ADDITIONAL EXERCISE

Exercise 13-1

Buying Merchandise to Match Consumer Trends

Please read the following articles and answer the questions below. Be prepared to discuss in class.

“Low-carb craze is fueled by the affluent.” MMR, June 28, 2004.

“The jury’s still out on low-carb diets.” MMR, February 23, 2004.

“Nutritious snacks are on the horizon.” MMR, February 23, 2004.

“Healthy, decadent in demand.” MMR, May 31, 2004.

1. Describe the consumer trends impacting the following three merchandise categories: food, snacks, and candy.

2. How should retail buyers respond to these trends to manage these categories, maximize sales, and meet the diverse set of consumer needs?

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ADDITIONAL EXERCISE

Exercise 13-1 with Answers

Buying Merchandise to Match Consumer Trends

Please read the following articles and answer the questions below. Be prepared to discuss in class.

“Low-carb craze is fueled by the affluent.” MMR, June 28, 2004.

“The jury’s still out on low-carb diets.” MMR, February 23, 2004.

“Nutritious snacks are on the horizon.” MMR, February 23, 2004.

“Healthy, decadent in demand.” MMR, May 31, 2004.

1. Describe the consumer trends impacting the following three merchandise categories: food, snacks, and candy.

- Americans are overweight and concerned with obesity

- Heightened interest in health and nutrition

- Is the low-carb diet a fad or a trend?

- 17% to 19% of households have a family member on a low-carb diet

- This diet is hard to stay on long-term

- More low-carb versions of food, snacks and candies are available and many new low-carb product introductions are expected

- Hefty prices charged for low-carb versions

- Legal issues – labeling requirements/regulations will likely change for identifying carbohydrate content

- Regular snacks are selling well

- Snack bars and cereal bars have shown solid growth in sales

- More restaurants are offering a low-carb menu

- Consumers are bipolar on candy, they want both healthy and decadent luxury candy brands

- People who buy low-carb foods are wealthy, educated, physically active, HHI > $75K, well traveled, fewer children, and use less coupons

- 32M carb-conscious Americas spent $2.5B on low-carb foods last year

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2. How should retail buyers respond to these trends to manage these categories, maximize sales, and meet the diverse set of consumer needs?

- Offer consumers a lot of choices: fat-free, sugar free, low-carb and regular/original

- Heavily promote these categories

- Educate consumers on the benefits of these healthy choices vs. the higher price

- Work with vendors to have the best merchandise available

- Place merchandise in more than one store location. Example: have chips in the snack aisle and near the deli counter

- Offer private label brands

- Plan shelf space carefully so consumers can find desired merchandise

- License popular characters and brands. Example: candy for kids that tie in with Harry Potter books and movies

- Add low-carb merchandise in wealthier zip codes

- Stock well known brands