Inventory: The Blob that Ate Your Checkbook

Is a glut of products starving your store of cash?

merchandising insights

Written By:
Jay Jacobowitz
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Jay JacobowitzYou know the feeling. You’ve just packed out your big order, or cut in space on your shelves for that hot new line, or built a promotional end cap for your monthly specials. Row upon row of neatly faced products beam brightly back at you. “Picture perfect!” you say to yourself.

Then, the feeling hits: “I hope customers don’t wreck my display!”

Is this a weird feeling? Not really. If you are like most retailers, you love your inventory. You believe that having inventory is like having money in the bank, only better, because you can sell it and make much more profit than the bank pays you in interest.

Buying inventory feels like investing in an income-producing asset that you can see and touch every day. It’s more tangible than buying mutual funds, stocks or bonds, where you have no control of the value. But, you do control your inventory; you keep it safe. Very appealing, right?

Wakeup Call
But, inventory isn’t an investment. Inventory is a necessary cost of goods sold. And, inventory only turns to profit if you sell it, and until you sell it, inventory sits on your shelf losing some of its value every day.

Have you seen the Progressive auto insurance TV commercials? The saleswoman asks the customer a series of questions like, “Are you a safe driver?” Every time the customer answers yes, the saleswoman yells, “Discount!”

Well, inventory gets discounted, too. As soon as you pack out a shipment, that inventory begins depreciating because it is no longer new. Discount! Every day that goes by is one day closer to the expiration date. Discount! While you’re waiting for it to sell, your “investment” gathers dust, which you must now pay someone to clean. Discount! Your biggest wakeup call may be when you try to sell your store and your buyer says you have too much inventory. DISCOUNT!

The Beauty of Retailing
There was a very high-volume, urban natural products retailer we’ll call Wanda, who was planning to expand and needed to borrow money for her new store. Like most lenders, the bank wanted to know how Wanda would use the money. In banker’s terms, this is known as “use of funds.”

Wanda explained that she needed money to buy new refrigerators, freezers, more efficient checkout counters, better lighting, shelving and flooring. The banker asked Wanda about inventory, which is a normal “use of funds” for a new store. But Wanda said she didn’t think she needed to borrow money for inventory.

When the banker asked why not, Wanda explained that she turned over—or sold through—her entire inventory every two weeks. The banker’s eyes almost popped out. Why? Because Wanda turned her inventory into cash every 15 days, but didn’t have to pay her supplier invoices for 30 days. This meant that Wanda’s checking account always had excess cash.

The banker whistled softly with newfound respect for Wanda. Because Wanda’s inventory converted to cash so quickly, it became a source of funds instead of a use of funds.

Now, here’s the really sweet part. Wanda’s excess cash in the bank averaged $50,000, so the banker arranged to borrow it from Wanda overnight—in what’s called an automatic “sweep” account—and paid her a half-percentage point in interest on the 24-hour loan, or about $70 a day! Wanda earned more than $17,000 per year in pure profit on her excess cash in the bank.

Turning inventory over quickly is the beauty of retailing, creating opportunities and giving you flexibility. Any steps you take to turn your inventory over faster will fatten your checkbook and boost your cash flow.

Less Is More
Because manufacturers typically use independent retailers to launch new natural products, you are bombarded with hundreds of new product choices every month. Some of these new items end up on your shelves. But, most new products fail because they are not truly delicious, innovative or better than what you already carry. So, what do you do with the losers?

Most retailers don’t have a good way of weeding out the duds, so shelves get more crammed over time. You know what happens next. In order to make products fit, you cut back on the number of facings—the same items side by side—of your good sellers, or convert your end caps to a permanent home instead of a temporary promotional display. Or, you set your shelf heights closer together to get another row of products into each bay or, in extreme cases, stack different sizes of the same item on top of or behind one another. This is counterproductive.

Studies show that people actually see only about half of what they view. So, at a minimum you should have two facings per item. If your store is entirely or nearly all single-faced, you are visually overloading your customers.

Stores that cut back on excess inventory and increase facings of top sellers find that their customers see many more items, even though there are actually fewer products. “I didn’t know you carried that!” is a typical reaction from shoppers after a retailer purges slow movers from the shelves. In merchandising, less inventory is definitely more efficient.

More Is Less
The explosion of new, but mostly “Me, too!” products over the last 15 years has made natural products retailers less efficient. The standard measure of retail efficiency is “inventory turns,” which is the number of times a retail store sells through its entire inventory value per year. In the mid-1990s, inventory turns for independents averaged nine times per year. Today, average inventory turns are six times per year; a 33% decrease in efficiency.

Another way to say this is, in 1995, a store selling $1 million per year typically carried $70,000 in wholesale inventory. Today, to sell $1 million, that store is carrying $105,000 in inventory. Slowing inventory turns down to six times per year from nine times per year has on average created a $35,000 blob of excess inventory that is clogging shelves and robbing retailers of scarce cash. Note: For our discussion, I am assuming a 63% cost of goods sold.

Today, the average store should be able to cut $3,500 in inventory costs out of every $100,000 in sales. Wouldn’t you like to have that money in your checkbook?

Table 1: The Real Cost of Excess InventoryWhat You Can Do
There are several steps you can take to tame the inventory blob that is eating your checkbook. First, you can be more disciplined about picking up new items. A simple rule of thumb is that a new product must have at least one of the following three traits: be delicious, innovative or better than what you now carry. Second, you should apply the same three criteria to “speculative” special orders. What I mean by speculative is that your customer has not tried the product, but has read or heard about it somewhere, and thinks he or she wants to try it. This is different from the customer who already uses a product that you don’t carry.

Third, set time limits for closing out slow moving products. For dry groceries, if you haven’t sold one piece of an item in a month, it becomes a candidate for a closeout sale. For refrigerated items, two weeks is a good guide. For supplements, 60 to 75 days is a reasonable amount of time to know if a product is going to be worth keeping. For personal care items, 45 to 60 days is enough time for the keepers to earn their keep. For fresh produce, you should be turning over your whole department no less than every nine days.

Table 2: Minimum Inventory Turns per Year-Select DepartmentsAs you can see, each product category has a different sales cycle. Fresh produce is fastest; supplements are slowest. If you are efficient in each category, your blended overall inventory turns for your store should fall somewhere between eight and 10 times per year, or about every 36 to 45 days. If your inventory is heavily weighted towards supplements, your overall inventory turns may be slower (lower number). If your store has lots of perishables departments like fresh produce, deli, cheese and bakery items, your inventory turns should be faster (higher number). Table 2 shows some benchmark inventory turns by product category for independent natural products retailers.

Inventory Lovers Anonymous
So, if you’ve ever had the feeling of wanting customers to stay away from your picture-perfect displays, try the “missing piece” trick. Leave one piece missing at the front of your display to make your shelves look “shopped.” Customers hesitate to disturb a perfect display, but a display that looks full-but-shopped makes customers want to grab the next product and put it in their carts. Try the missing piece trick the next time that picture-perfect feeling comes over you. You’ll sell more stuff. I promise. WF

Jay Jacobowitz is president and founder of Retail Insights®, a professional consulting service for natural products retailers established in 1998, and creator of Natural Insights for Well Being®, a holistic consumer marketing service designed especially for independent natural products retailers. With 32 years of wholesale and retail industry experience, Jay has assisted in developing over 800 successful natural products retail stores in the U.S. and abroad. Jay is a popular author, educator, and speaker, and is the merchandising editor of WholeFoods Magazine, for which he writes Merchandising Insights and Tip of the Month. Jay also serves the Natural Products Association in several capacities. He can be reached at (800)328-0855 or via e-mail at jay@retailinsights.com.

Published in WholeFoods Magazine, March 2010