Many retailers use the performance indicators of gross margin % (after markdown) and weeks cover to measure performance. While the Gross margin% is a measure of relative profitability without taking into account the cost of stockholding investment, week’s cover tells us how effectively the stock turned, without informing us about relative profitability. What is needed is a measure that combines these two indicators into an indicator of real profitability. GMROI does this.
GMROI is calculated as Gross Margin / Average Inventory at cost:
GMROI is a merchandise planning and decision making tool that assists the buyer in identifying and evaluating whether an adequate gross margin is being earned by the products purchased, compared to the investment in inventory required to generate the gross margin. It focuses the buyer’s attention on the return on investment rather than on sales as a basis for merchandising decisions. The focus is on SKUs (stock keeping units) of each individual product rather than department totals and it keeps identify product winners’ and core products.
Product winners are those products that perform well, which boost profitability and are the best return on investment products. Core products on the other hand, are the buyer’s list of existing winners that can never be out of stock. They’re the most valuable products in terms of their high profitability and their excellent return on investment.
Gross margin is the value of sales less the cost of goods sold. Increasing gross margin entails increasing sales revenue or reducing the cost of the merchandise. The obvious way to increase sales revenue is simply to increase prices. Unfortunately in a competitive environment things are not that easy. The recommended approach is to avoid products that are known value items or those that your competitors focus on for price comparisons. Merchandise managers who can effectively inter-relate gross merchandise management and inventory turnover management will be able to achieve high performance results.
Another method of managing inventory investments is to predetermine the stock levels at which merchandise should be reordered. This is known as the reorder point. Various factors like the lead time required the safety stock and the speed at which the products sell, have to be taken into consideration. It may not always e possible for a retail buyer to place orders for products in small quantities; hence the Economic Order Quantity (EOQ) is determined. For this purpose, it is necessary for first to determine the sales for the product, then take into consideration various factors like cost, discounts and the cost of holding inventory and then the Economic Order Quantity (EOQ) is determined . The EOQ is calculated by using the following formula:
EOQ= 2DS / IC
D= annual demand
S= cost to place the order
I = percentage of annual carrying cost to unit cist and
C= unit of an item
The EOQ model assumes that the unit cost of an item is constant, irrespective of the quantity of order placed. In practice, for large order quantities, discounted price and transportation costs are given. Such discounts cannot be accounted for in the EOQ model.
Many a times, the retailer may also use the concept of Direct Product Profit (DPP) to measure the performance of a product. DPP focuses on the contribution profit of individual retail items in individual stores. Direct Product Profit (DPP) equals an item’s gross margin dollars, plus discounts and allowances earned, less direct handling, selling and inventory holding costs. DPP enables the retailer to develop results for brands, categories, departments, stores etc thus forming the basis for merchandising decisions.
By expressing DPP against a common unit of measure (floor space) retailers can compare the performance of products of different physical proportions. Since retail space is usually limited DPP can be used for:
1. Item selection (high DPP items should generally be added, low ones reviewed with an eye towards pruning).
2. Store/Shelf location (high DPP items should be given prime location) and
3. Promotion (total DPP can be improved by increasing the sales of high DPP product).