In the late 1800s, an economist named Vilfredo Pareto undertook a ground breaking study of the distribution of wealth in Italian society. He found, unsurprisingly, that eighty percent of the wealth was concentrated in the hands of twenty percent of the population. He was subsequently amazed when, in conducting similar studies of other European countries, he found that each, regardless of their political system, evidenced precisely the same allocation of personal assets. This universal pattern in the distribution of wealth became known as Pareto’s Law.
Since then, similar patterns in data have emerged as experts in a variety of fields discovered that this 80/20 ratio applied to a vast array of phenomena. Today, we don’t call it Pareto’s Law anymore; we simply refer to it as the 80/20 rule. In my ongoing attempts to derive mathematical models for consumer behavior, I have come to share Professor Pareto’s surprise over the broad applications of his discovery. One of my favorites is that 80 percent of the beer is drunk by 20 percent of the beer drinkers (a fact that may support the notion that 20 percent of us have 80 percent of the fun!)
In recent years, most jewelry retailers have come to accept an important application of the 80/20 rule. When evaluating inventory turn, it’s now fairly well recognized that for most of you, 80 percent of your sales come from 20 percent of your inventory. And as I review the monthly sales data of over 250 Edge Retail Academy client stores, it has become clear to me that this “Inventory Productivity Ratio” is often even more extreme. It turns out that in many stores, about 8 percent of the inventory is producing 92 percent of the sales.
This is happening for a variety of reasons. The most obvious is that many stores are loaded with aged inventory that’s not selling, so the stuff that actually does sell comes from a thin sliver of the pie chart represented by “fast-fast sellers.” But it’s also the result of an increasing trend towards the application of professional retailing skills, particularly related to an increased awareness of the need to replenish sold inventory.
These stores are stuck with dead inventory, but at least they’re reordering fast sellers, since these get a chance to turn repeatedly only when they keep coming back into inventory, allowing like-minded consumers to purchase them again. And partly, it’s a reflection of the increased homogenization of consumer preferences, due to the impact of national advertising and the Internet. It’s now a demonstrable fact that the same stuff that sells well in one place sells pretty well everywhere. It’s also a fact that, sadly, the much larger subset of non-selling stuff doesn’t sell well anywhere.
Knowledge of what sells (and what doesn’t) derived from sell-through data from hundreds of stores has allowed me to fine tune Gems One’s approach towards product development and shelf-stocking, to the extent that we now have over 70 sku’s that sell, on average, in less than 40 days in the Edge Retail Academy stores. This is clearly related to the fact that we’re producing the right stuff at the right prices, but it’s also a reflection of the increased emphasis that our customers are placing on continuous inventory monitoring and replenishment.
Close analysis of the data yields some interesting patterns. Of particular importance in the context of this article is the dramatic impact that late season reorders have on annualized inventory turn. In many cases, between one quarter and one half of the annual sales of key sku’s occur during the month of December. It seems to me that this is an important insight, and it causes me to make several observations regarding an appropriate empirical approach to reorders in December.
The first is that your December reorder methodology may require an adjustment in your overall buying pattern. If you’re still applying the old school “buy a bunch of stuff during the Summer with seasonal dating” approach, then continuous reorders throughout December can actually create a cash flow problem, as fast-fast sellers sell continuously at an ever-increasing pace, while the massive quantity of stuff you bought that didn’t sell is still in the showcases on December 26 (but must still be paid for).
In the era before computerized POS inventory control systems, the need for significant seasonal peaks in inventory was manifest, but in the current era, it just no longer makes sense. Let’s assume that you do 22 percent of your annual business in December. Is there really any reason to incur an inventory spike of greater than 10 percent to accommodate increased demand, especially when you can select vendors that maintain shelf stock in key items?
Given the seasonality of our business, it does make sense to peak your inventory. I just urge you to do it in a controlled, modest way. The mathematics of this is pretty easy to understand. Let’s consider a store with annual sales of $1 million, expecting to generate about $220,000 in sales during December. At a 50 percent gross margin, this store will metabolize about $110,000 at cost in goods during the month. Assuming 30 percent of those sales come from memo or reordered key items, that yields a net inventory reduction of about $77,000. If the store has an average standing inventory of $700,000 (consistent with an annual gmroi of 72, which, sadly, is typical), then an initial inventory peak of 10 percent (in this case, $70,000) will allow you to finish the month at the average standing level. This is particularly important from a cash flow standpoint, because it means that you will complete the selling cycle without a net inventory increase, so that your profits will end up in your bank account, and not in your showcases.
This does not, by the way, mean that you should accept a dismal gmroi just because it’s the norm. Ultimately, a store generating $1 million in sales with $700,000 at cost in inventory needs to either dramatically reduce its inventory, or significantly increase its sales. And a necessary element for achieving a sales increase is to make sure that the inventory on hand is the stuff that buyers want to buy, which means you really need to get religion about reordering, because the single greatest predictor of what’s likely to sell today is what sold yesterday.
A second important factor to consider is the allocation of inventory price points compared to actual sales. It has been my experience that almost every time I analyze a store’s inventory in this area, the distribution of inventory by price point doesn’t even faintly match actual sales. I suspect that this is partly a perceptual problem.
I recently held a sales training seminar in one of our customer’s stores that was attended by 18 very knowledgeable staff members. When I asked them to estimate the store’s average sale last December, most guessed somewhere between $550 and $700. The actual value was $221. This misperception is generally not isolated to staff, but rather is typically held by owners as well, so that when it’s time to buy, owners often orient their buying towards merchandise at price points that are much higher than actual sales. The bottom line is that while it’s fun to catch whales, you can’t catch guppies with whale bait, so make sure that what’s on the shelf matches what’s being sought by your customers.
Finally, if you analyze your company’s sales data for the past several years, you are likely to find that the midway point in your December sales typically falls sometime late on the 17th or early the morning of the 18th. From a practical standpoint, you may find it difficult to receive, tag, and re-stock items this late in the game, but I urge you to try to do so. You’ll not only have the right styles when it matters most, your inventory will also reflect the price points that are actually selling, which means that whether this Christmas ushers in a return of higher price point sales, or continues the trend of lower average tickets, you’ll have the right product selection when the store fills with motivated buyers.