Evaluating Merchandise Performance

Measuring the performance of merchandise is necessary in order to gain an understanding of the products which have performed well and which have not performed as per the target. The performance can be as per plan, below the plan or above the plan.

Inventory turnover, which may also be called inventory or merchandise stock turn or just turnover, is a key to merchandise performance. Inventory turnover measures how long inventory is on hand before it is sold. Items that are on hand a short time have a high turnover those that are on hand longer having a low turnover.

Retailers calculate inventory turnover in several ways:

1) Net sales /average inventory at retail
2) Cost of merchandise sold / average inventory at cost
3) Units sold /average units in inventory
4) Net sales = turnover * average inventory at retail.
5) Average inventory at retail = net sales /turnover

Turnover is a key to high performance, which means profits in retailing. However, higher turnover will not indefinitely increase profits, and the lowest profits, and the lowest turnover will not necessarily result in the lowest profits.

Rapid turnover enables the retailer to reduce certain expenses. Lower inventories will obviously require less capital, and thus the retailer’s interest expenses will be lower. Also associated with lower inventories will be lower levels of insurance coverage required, lower inventory taxes on year end inventories and lower cost of space to store the inventory. On the other hand, rapid turnover can increase expense. With similar average inventories on hand, the retailer must order more frequently and in smaller quantities, resulting in higher clerical costs, lost quantity discounts and higher transportation rates.

Success in retail can be measured by the amount of profit generated in relation to the working capital invested i.e. the return on investment. Certain costs in any business are fixed or at least are not easily flexed. Shop rents and head office costs fall into this category. Merchandise margins and product mix, however, are variable and their management can either enhance or destroy profitability.

Many retailers use the performance indicators of gross margin % (after markdown) and weeks cover to measure performance. These are very commonly available but used in isolation from each other, they are of limited value. Gross margin % gives us a measure of reactive profitability without taking into account the costs of stockholding investment. Weeks cover tells us how effectively we turned our stock without informing us about relative profitability.

There are three methods of analyzing merchandising performance:

1) ABC analysis
2) Sell through analysis
3) Multiple Attribute method.

ABC Analysis: Pareto (ABC) Analysis (a.k.a 80/20 Rule)

ABC analysis rank orders merchandise by some performance measure to determine which items should never be out of stock, which items should occasionally be allowed to be out of stock and which items should be deleted from the stock selection. An ABC analysis can be done at any level of merchandise classification form SKU to department.

ABC analysis utilizes the 80:20 principles which imply that 80% of the sales come from 20% of the products. The first step in the ABC analysis is to rank order SKU’s using one or more criteria. The most important performance measure for this type of analysis is

Contribution margin:

Contribution margin: Net sales – Cost of goods sold – Other variable expenses

The next step is to determine how items with different levels of profit or volume should be treated differently. The buyer may define as A items those that account for 5% of items and represent 70% of sales. B items represent 10% and 20% of sales. C items account for 65% of the SKUs but contribute only 10% of sales and D as those items for which there were no sales in the past season.

Sell through Analysis:

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. There is no rule which can determine when a mark down is necessary. It depends on experience with the merchandise in the past, whether the merchandise is schedule to be featured in advertising or whether the vendor can be reduce the buyers risk by providing markdown ,money etc.

If actual sales stay significantly ahead of planned sales, a reorder should be made.

Multiple attribute Method:

This method uses a weighted average score for each vendor. The following steps are followed:

1) Develop a list of issues to consider for decision making, like vendor reputation, service merchandise quality, selling history etc.
2) Give importance weights to each attribute
3) Make judgments about each individuals brand’s performance on each issue.
4) Combine the importance and performance scores
5) Add all to arrive at the brand scores.