Key Retail Profitability Management Practices And Indicators

INVENTORY MANAGEMENT PRACTICES AND KPIs

Proper KPIs are fundamental to efficient inventory management, as these indicators drive future performance and profit. Most KPIs are coupled with inventories as a primary asset of the retail business and with sales as the ultimate result in retail. It should also be understood that an excessive number of KPIs “blurs” the contribution of everyone, and too few do not give the whole picture. Therefore, it is worth determining both the quality and quantity of KPIs in each business area that you manage.

Typical indicators are: 

• Inventory costs;
• Sales;
• Overstocks;
• Lost sales;
• Service level;
• Inventory turnover.

Aside from inventory indicators, some indicators affect them directly or indirectly: supplier reliability level, delivery lead time, demand variability, terms of deferred payments to suppliers, the financial cycle, and others. We will mention them in the context of each indicator.

Why is it important to calculate these indicators?

You can do without that calculation, but no one in the company will be able to understand exactly what operating activities the money is invested in and when it will profit.

Each of the KPIs above is responsible for one of the facets of inventory management. There is overstock in the inventory structure, but information about the percentage and overstock cost provides insight into the effectiveness of purchasing logistics. Lost sales provide information about the income lost because of an insufficient level of product availability. When calculating these indicators, both line and senior 

Now, let us take a more detailed look at each of the above:

An INVENTORY COSTS indicator is used for a general understanding of the business’s investment in stock on hand and its dynamics over time. 

To accurately calculate the inventory costs, the stock on hand at the prices of the batches in which the delivery of this product took place is used, since the purchase price varies depending on the batch.

Except for tracking this KPI dynamically in the moment, the assessment of the structure of stocks clearly demonstrates how much the insurance stock, display, surplus, and the sales inventory cost the company.

Monitoring dynamics should be paired with continuous assessment of the general stock structure with a focus on: 

1. Safety stock costs (GREY), 
2. Overstocks (BLUE), 
3. Sales demand (GREEN).

SALES (in purchase and sales prices)

Sales is the most analyzed KPI in retail. Besides the main function of generating turnover, the sales give an idea of the nature of demand, the range quality, the promotion effectiveness, the quality of merchandising, and operational personnel. In fact, everyone in a retail company works for the good of sales. From the point of view of category management, sales are analyzed by categories, from POS, suppliers and other dimensional perspectives.

Making informed management decisions requires reliable data to support each decision. Many successful retail companies rely on ABC(D) analysis as the basis. ABC(D) is also widely used in category management as it helps identify category performance by looking at sales or margin. It also defines the assortment as sales generators (A) and dead stock (D).

OVERSTOCKS - indicate the percentage and value of inventories purchased in excess or that appeared as a result of declining demand. This is an excess stock that is created due to a decrease in sales or an over-ordering of goods. In fact, a surplus is perfectly normal; there are overstocks in any retail chain. The question is only about the excess stock percentage. Overstock can have the following objective reasons:

• decrease in demand;
• post-promotion surplus;
• advance preparation for seasonal holidays. 

But in our practice, surpluses often arise as a result of mistakes made in inventory management: buying a large number of goods with a supplier discount without an accurate calculation of economic feasibility and other actions aimed at increasing inventory for no reason. Besides the very fact of the surplus, it is worth evaluating how long this surplus has been on the shelf or in the warehouse.

Related: How using inventory management machine learning could improve your retail business?

Surplus stock requires long-term monitoring to be able to identify products that generate the highest surplus. You can further decide on how to manage it in one of the following ways:

1. Redistribute internally. Before choosing this path, you have to analyze the stocks and surplus structure, as well as assess the needs of the POS where the move is made. It is important that this process be automated or partially automated.
2. Return to the suppliers. Returns are quite expensive: they must be properly organized starting from the goods collected in the store and documenting and sending them back to the supplier without loss. The organization of this process can be costly. Therefore, retail chains increasingly don’t make returns to suppliers. 
3. Discount the products. When choosing this strategy, it is important to build a holistic picture, choose paths with the least risks, and weigh this against the benefits for each outlet.
4. Utilize.

LOST SALES  - indicates the percentage and value of statistically potential sales that did not occur due to lack of stock.

Lost sales can be caused by: partial or complete under-delivery from the supplier, lack of parameters for ordering, sharp increases in demand for specific groups of goods, cannibalization and other reasons. Lost sales often result from a combination of these factors. So it is important to focus on the most common cause and increase the availability of the product and its sales.

It is difficult to get an absolutely accurate figure for lost sales due to the specifics of the KPI itself, but this doesn’t mean that lost sales should be completely abandoned when analyzing the inventory management efficiency.

The LEAFIO INVENTORY OPTIMIZATION solution features a lost sales report that indicates the reason for each lost sale and shows the latest dynamics by category or group. Such granularity can easily identify the root cause of the problem and address it in time.

SERVICE LEVEL - Percentage of assortment available on the shelves. This signifies the assortment matrix fulfillment and product availability at the locations. It is similar to lost sales, but is measured in pieces instead of money. Service level is an accurate indicator of the product availability on the shelf and is one of the two key performance indicators used by inventory managers. The second indicator is inventory turnover. 

INVENTORY TURNOVER is the inventory ratio to sales, indicating how many days of sales the current balance will sustain. It is commonly referred to in either days or a number of times (yearly) when the entire stock is sold. Inventory turnover is a relative indicator and is often used for a specific category, brand, supplier, or company as a whole. 

Sales can drop without compromising availability. Then the issue may be with the range. It could have become less relevant for customers or to sales promotion or the sales floor customer experience. If there was no decrease in sales, it is possible that there was an increase in inventory. In this event, you have to analyze whether the surplus has increased. 

If this is not the case, but the stock has grown, you should understand why this has happened: perhaps new stores have opened, the demand of which has not yet reached the target level, and then you just have to wait. Perhaps the stock has increased due to seasonality. However, the retailer is usually aware of these nuances. If there was a deterioration in turnover, not supported by events, this is an occasion for deep analysis to see the cause for this growth.

MERCHANDISING PRACTICES AND KPIs

Evaluating shelf space and store plan performance can create a more efficient shelf display that is attractive to customers and directly impacts store profitability. In merchandising management, such indicators are:

• Shelf space profitability;
• Shelf space returns;
• Profit share ratio;
• Elasticity.

SPACE PROFITABILITY measures the effectiveness of the display through the profit the goods are generating in a given area and how fast the products are turning. 

There are several metrics you need to track how much profit the goods placed in the display area bring, their turnover, etc.

Correct profitability indicator helps to:

• display the effectiveness of the use of retail space per meter;
• display the profit from each meter of the layout to evaluate the performance of a category.

How do you get it?

Sales per meter = gross profit ÷ linear meter of the calculation

Face profit helps to display the amount of profit from each face in the category.

How do you get it?

Face profit = gross profit ÷ number of facings

Stock profitability helps to show the profit from each inventory unit.

How do you get it?

Stock profitability = gross profit ÷ money stock equivalent on the shelf

Comparing the dynamics of the indicators gives a clear understanding of the shelf space performance: 

• efficiency deviations of a particular store compared to the company’s benchmark;
• category display efficiency for each store;
• category shelf display efficiency within a store/department/planogram, etc.

These indicators serve as a basis for regular planogram review and adjustment that drives the efficiency of the macro space, revenue, and margins. A perfect scenario would be for the merchandising manager to automatically recalculate facings in the merchandising solution by employing the indicators above in an algorithm and sending updated layouts to the locations. 

SHELF SPACE RETURNS indicate the sales area efficiency and help identify the poorly performing sales area in a store. It is calculated for each category, supplier, SKU, and reflects the ratio of the allocated area to sales. It assesses how well the space is distributed between categories and reveals whether a category is represented properly in terms of profits it generates in a given area. 

The LEAFIO PLANOGRAM OPTIMIZATION solution features built-in analytics on SHELF SPACE RETURNS that can be conveniently viewed in a dashboard or a table. 

PROFIT SHARE RATIO (planogram products facings to profit share) indicates whether the space has been allocated correctly for each SKU. The SKU facings to the SKU ABC-analysis position holds the key to profit increase. Keeping the ratio at a minimum leads to a rise in the profitability of the layout.

ELASTICITY reflects the profit potential of merchandising and determines the possible change rate of GMROS (gross margin on selling space). This defines the effectiveness of the sales area.

Merchandising analysis helps improve sales and turnover performance as well as monitor assortment performance and manage surplus or shortage of goods. Assessing efficiency impacts the layout accuracy, compliance with supplier agreements and internal requirements, and improves the customer experience. 

To summarize, the KPIs above hold the potential to drive retail profits up and give clarity on operational performance at a time when circumstances change constantly. Please visit www.leafio.ai to learn more about retail process optimization practices and solutions. 

Related: All About Planograms: Usage in Retail