When I want to learn about supply-chain management, I like to find somebody who’s been managing inventory since back when the data was entered with punch cards. Recently I found exactly this person while browsing the Internet: Jon Schreibfeder, president of consulting firm Effective Inventory Management in Dallas. Schreibfeder keeps a helpful archive of articles on supply-chain and inventory management on his company Web site.
I thought I knew a lot about supply chain from my 12-plus years reporting on retail full-time, but I learned some new twists from Schreibfeder. We chatted recently about category management: evaluating an entire merchandise category for profitability rather than only analyzing margins on individual items.
Schreibfeder’s category management process starts at the item level and works its way up to looking at the whole category. Many small business owners don’t take the time to analyze whether each stock-keeping unit in their inventory is really making money.
Often merchants are too focused on quickly figuring gross margins, simply the price you sold the item for minus the price you paid for the item.
What’s missing from that equation? Carrying cost, the cost of storing the item in your warehouse or displaying it in your store for however long it takes to get the item sold.
To help, Schreibfeder provides a free worksheet on his site for calculating the labor, rent, utilities, finance charges, and other costs of keeping merchandise handy. Once you add carrying cost to the price of your item, you have what Schreibfeder calls “adjusted gross margin,” which is a more accurate measure.
Armed with adjusted gross margin figures, Schreibfeder analyzes profitability and divides inventory into three categories, which he cinematically dubs “the Good, the Bad, and the Ugly.” Good inventory makes you money. Bad loses money, but its presence enables the sale of more profitable Good items. Ugly goods, as you may have guessed, are just plain losing you money with no upside and need to be cut.
When you know the true profit on each item, you’re ready to evaluate whole categories to make sure they’re profitable overall, or at least leading to profitable sales in other categories. With complete knowledge of each item’s role in your profit picture, you can make wiser decisions on what to stock in the future and make sure each product category presents an assortment that’s complete enough to lure customers without carrying needless “dog” items.
Next, look at inventory turns. Do you need to buy this item in volume to get a discount or it isn’t profitable? Or can you still make money ordering smaller amounts at a time and saving on storage? What if you don’t sell enough volume at full price and have to discount the rest of the stock? Is it still profitable? Schreibfeder gets merchants focused on the mantra: Profitable items add up to profitable categories, and profitable categories mean you’re making a profit.
“I get a lot of yawns when I say, ‘We’re here to discuss inventory turnover,'” he says, “But when I say, ‘I’m here to discuss the opportuity to earn profits,’ everybody wants to hear that.”