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Inventory: the right investment
Why you should invest your money in inventory
“Good merchandise, well displayed and reasonably priced will always sell well.” This is an old adage of retailing this writer remembers first hearing over 40 years ago. It was true then; it is true today. Notice that selling merchandise has three components. There is not a second sentence to the adage, but it could be a safe assumption that a business would have a problem if not properly addressing all three.
Where do we as retailers make mistakes with inventory? If you are like most other retailers there is not a one situation in which we make a mistake with inventory, but many challenges with inventory.
If you are reading this article you have likely survived the great recession. While you may have made some mistakes with inventory, you probably did the job of inventory control well enough that your business is one of those that is still open to do business.
Selecting and displaying the merchandise
To maximize your investment in inventory the first aspect you have to consider is selling ‘good’ inventory. The problem lies in who is defining the word ‘good’. Many retailers select inventory based on what they like. As a buyer if you are going to insist on buying merchandise you like, then you are going to have to be sure you find customers that like what you like. Simply stated, it is not important if you like the merchandise; it is important that you have merchandise your customers like. ‘Good merchandise’, good needs to be defined by the customer – not by the buyer.
The second component of the adage is ‘well displayed’. Many retailers like to take pride in thinking they have customers that frequent their store. When a customer first arrives in the store and says to the sales person, ‘I don’t need any help; I know where everything is”, too many retailers take that as a confirmation of the frequent customer. However, it also means that the customer is not likely looking around to see other items.
‘Well displayed’ means it has to catch the customer’s attention. That which catches a customer’s attention on one visit is not likely to catch their attention on a second visit if the display is in the same location or has not had some component changed.
How much do you charge for an item?
It is in today’s economy that the third component of the adage, ‘priced right’ is given the most attention. Simply said, lowering your price is not going to be the solution to a sales problem. Need proof? Determine what you want to see as a result of lowering prices; do you want to increase your total sales or your gross profit dollars.
A simple mathematical calculation will tell you how many more of an item you have to sell of an item with a lower price to produce an increase in gross sales dollars. A similar calculation will tell you how many more of an item you have to sell to increase your gross profit dollars.
Determine what the quantity is that you have to sell and you then have to give serious consideration as to whether or not you believe you can achieve that increase in the number of that item being sold. If you are not going to hit the higher gross sales dollars, then why would you lower your price?
When the store does not achieve the higher gross profit dollars, then selling at a lower price will simply mean there is less inventory in the store and less money to pay the operating expenses.
The price of an item should be determined by only one factor; it is the buyer examining the product and asking, ’how much can I get for this?” The answer to that question, and only that question makes the determination of the price of an item. The hard part is deciding if the store is going to be OK with that selling price when compared to the cost of the item.
Too many retailers simply look at the margin and let that be the determining factor in stocking the item. As an example, let’s look at three items – you can decide whether or not your business should stock the items.
The first item has a cost of $5.00 and you decide to ‘keystone’ it to sell at $10.00. Your gross profit is $5.00 and your gross margin is 50%. You buy the item six at a time and reorder when you have two left on the shelf. Over the course of a year, you sell 20 of these for a total gross profit of $100.
The second item has a cost of $1.00 and you decide to sell it for $1.49. Your gross profit is forty-nine cents and your gross margin is 33%. You buy the item one dozen at a time and reorder when you have six left on the shelf. During the year, you sell twenty dozen of the item for a gross profit of $117.60.
The third item has a cost of $1900 and you decide to sell it for $2,000. Your gross profit is $100 and your gross margin is a mere 5%. You buy the item one at a time and when you sell the one on the sales floor you order a replacement. You sell only one during the year for a gross profit of $100.
Which of these items do you want in your business? Which of these would you stock? At the end of the year, each has contributed approximately $100 toward your bottom line. You could consider the inventory turn, gross profit dollars, and you could consider how many dollars you have to invest to stock the items.
The answer you choose is the one you think is best for your store. You can choose between the three, any combination of the three, or all three of them. The suggestion is that you consider the answer is to blend all three. Rarely is there one answer that is right for all businesses.
Determining the quantity of merchandise is the key
Looking again at the idea of lowering prices, if a business is lowering the price of merchandise because of a desperate need to get some cash in the register, the business likely has other financial challenges. Selling off inventory is not going to solve that problem. Perhaps the idea of selling off inventory is because the buyer simply believes they have ‘just too much inventory’.
Other than lowering prices to increase gross sales dollars or gross profit dollars, many retailers talk about their having too much inventory because of the economy. Unfortunately in correcting this problem, retailers have too often decided to simply lower the inventory in their business. They do so by either lowering prices to create a sell-off, or by simply stopping their ordering. This can be a wrong move, and potentially fatal move, as ‘you can’t sell from an empty cart’.
Without question, inventory is the best place you can possibly invest your money. You surely know more about inventory than the stock market. And as you look at the sign in front of a bank, every retailer can make more with their inventory than the bank offers on a certificate of deposit.
Where inventory goes wrong is that too often a retailer is over stocked in a particular area, or areas, of merchandise; not in the store as a whole. This calls for a retailer to implement and utilize an inventory control system.
While many point of sale systems offer a min-max system of product replenishment, it does take the system a long while to understand the seasonality of product sales. The system is not going to understand a sales spike that can occur because of a single sale to a customer of a substantial quantity.
Inventory control begins with the shop owner determining how much inventory they can afford as well as how much inventory they need to produce the anticipated sales. Between the two numbers the shop owner will have to make a determination of the appropriate amount, remembering that money sitting in a checking account does not produce profit.
Anticipated sales should be broken into categories. As an example, if you sell greeting cards they could be a category. Kitchen items could be a category as could bathroom items. The key to defining categories is that no category should be more than 5% of your gross sales or so small that your budget is a very minute amount.
As retailers are often overwhelmed by the min-max of a point of sale system, looking at inventory control in manageable ‘chunks’ can help to cause the concept to become more functional.
Inventory is often the largest investment a person has in their businesses. That investment should be made as wisely as possible. Better inventory control leads to a higher return on investment. Isn’t that why you selected each of those items to sell? After all, good merchandise, well displayed and reasonably priced will always sell well.
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This article is copyrighted by Tom Shay and Profits Plus Solutions, who can be reached at: PO Box 1577, St. Petersburg, Fl. 33731. Phone 727-464-2182. It may be printed for an individual to read, but not duplicated or distributed without expressed written consent of the copyright owner.
Profits Plus Solutions, Inc.