JTPP: Localization’s Inventory Dilemma
By Nikki Baird, Managing Partner,
RSR Research
Through
a special arrangement, presented here for discussion is a summary of a current
article from The Journal of Trading Partner Practices (JTPP),
the official online publication of the Vendor Compliance Federation (VCF),
Trade Promotion Management Associates (TPMA), and the Federation of Credit
and Financial Professionals (FCFP).
While economic conditions
have forced retailers to slash inventories as quickly as possible, localization
has caused them to rethink what the “right” level of inventory is to begin
with.
Localization is an
offshoot of retailers’ pursuit of customer centricity. In response to the
power that virtual channels like e-commerce and mobile give to consumers
in the retailer-customer relationship, retailers have been working hard over
the last decade to increase their relevancy to consumers. On one side, that
has meant more personalized communications and offers. On the other side,
it has meant localization of inventory.
At its extreme, localization
of inventory means creating a custom assortment based on a store’s unique
characteristics and demographics. The reality of localization is a little
less extreme: retailers on the leading edge of these initiatives have found
that customizing 25-30 percent of the assortment by store creates an impression
among consumers that the retailer has totally customized the assortment –
the challenge is picking which 30 percent to customize.
But another challenge
has arisen from localization, and that is pressure on inventory levels. If
you require that localization of inventory happens without increasing the
retailer’s overall level of inventory, the only way to do that is to risk
an increased rate of stockout. Put simply, you’re spreading the same amount
of inventory over a larger number of SKU’s. Something has to give.
The biggest
question regarding localized inventory has been exactly this – what will
retailers give to get localized inventory, and is it worth it? Will they
keep inventory levels the same and risk the customer experience in the form
of stockouts, or will they increase inventory in the hopes that they sell
more to cover the investment needed?
The answer, according
to RSR’s latest research on inventory, is that winning retailers have placed
their bets on increasing overall inventory levels (see Figure). The bet has
apparently paid off: winners also report improved margins and improved turns.
How
does this work exactly? By carrying more products that are relevant to specific
customer groups (instead of averaging allocation across stores), these retailers
are able to sell more inventory closer to full price – despite the initial
investment required in terms of carrying more inventory. The key to achieving
this, though, lies in the processes and technologies that support localization.
If you have a supply chain designed for case-level flow straight to stores,
for example, you’re not just going to have to increase inventory, you’re
going to have to give up some distribution efficiencies to break packs and
ship mixed cases.
Retail winners are fully aware of these kinds of implications,
and are positioning themselves now to deal with the process impacts of
localization.
Discussion Questions:
Does the push toward inventory discipline work counter to localization
efforts? Are the benefits of localization worth those inventory risks,
especially in today’s climate? Are there ways to reduce those risks
when pursuing localization strategies?
So the report says that having stock leads to increased sales? Am I missing something? Service levels are the priority of any store manager or director, and keeping the assortment localized is a huge component to the total mix. Especially if you are a grocer.
I don’t like to use the terms ‘giving up’ when it comes to merchandising. There is always shelf space available for what can sell, in my opinion. Optimization must come from the store level. That team knows their customers’ wants and needs better than anyone else.
This is pretty basic stuff. Retailers and wholesalers carry inventory. It is one of the important things that they do. They make money on most of it, but not necessarily all of it or even the same amount. The only thing that matters here is if the retailer knows what to buy. Period.
The discussion about the amount of time that they can afford to hold inventory can be a very lively debate. But given the size and efficiencies of the supply chain, we’re talking about a fraction of a penny on each item sold for inventory carrying costs. The debate is really around the space costs–are they fixed or variable? Now you’re talking about whole pennies.
A telling stat is the fact that the most successful retailers have their ‘localized’ inventories at about 25%, which induces the feeling among customers that the entire inventory is localized, which boosts brand impression and sales. I think that’s key to remember. So, simply put, if you’re struggling with inventory levels for the most important component of your inventory, then you’ve got to give it priority in terms of resources: ‘local’ buyers (whether they’re in the home office or not), additional planners, daily shipments, better relationships with vendors that contribute to this portion of the inventory and finally, great merchandising and reporting from the field. Building a sense of urgency around this inventory by showing you mean it with resources will permeate the organization.
There’s an evil part of my merchant side that says, with certain items, what’s so bad about being out of stock every now and then? You create a sense of urgency for your customers (this may not be here tomorrow!) and generate excitement with associates. Of course, being out of stock occasionally is one thing, but you’d better follow up with either more of that quickly or the next hot item. Because as we all know, consistently missing your sales plan just means you’d better start looking for another job.
A localized assortment will certainly boost revenues and margins. Based on my experience in doing this, however, there is no requirement to raise total inventory levels. In fact, layering incremental inventory on top of a standard assortment will boost sales and margins in the short run, but will increase markdowns and reduce margin over the long run since sales of localized items are not 100% incremental. The real challenge is managing multiple assortments (this local SKU replaces this standard SKU in this subset of stores). This sounds simple but is actually very complex.
The size of most merchandising organizations (buyers, planners, controllers…) is based on a standard assortment in all stores. The merchants plan, buy, and merchandise “The Big Store” or aggregate demand. They buy from large vendors where they have long-term relationships and leverage. Their reward systems are usually geared to total sales. They live for the “killer” SKU that pops total sales. Localizing inventories requires managing significantly more SKUs in smaller quantities. These SKUs, individually, do not move total sales significantly. It also usually means working with lot more vendors, as well as multiple planograms. Put simply, from a central merchant’s view, this is a lot more work and complexity to get to the same place.
The challenge of localization is organizational. How many merchants/planners are in the organization, where are they located, what are their reward structures, etc, etc.
The good news is that, in most cases, the number of additional SKUs to achieve a local feeling is not as important as how they are presented on the sales floor. I think RSR’s number of 20-30% of store inventory is way too high. My experience is that you can get a local feeling with less that 5% of a store’s inventory if you present it intelligently.
Absolutely not. In fact, localization can be ripe with inventory benefits like reduced inventory costs, reduced waste, reduced backroom costs and reduced stock-outs. With retailers we work with, after analyzing their data we have found that most inventory issues could be traced back to the assortment. Typically SKU rationalization/localization exercises do not consider inventory as a factor, which leads to downstream challenges.
Some of the factors other than store performance data like (Sales $, Volumes and Margins) we have identified that need to be considered while localizing the assortment are:
1. Demand Transfer – Typically when a SKU is delisted, a percentage of its demand is transferred to other similar SKUs. If this demand is not considered, the probability of stock-outs of listed SKUs increases. Hence the listed SKUs need to be stocked more. Demand transfer is the parameter that explains retailer’s bets on higher inventory–They actually sell more when they keep what is more relevant.
2.Inventory Parameters – This includes parameters like presentation minimums, case pack constraints (minimum case pack), replenishment frequency (how often the store is serviced), product shelf life and others. In fact, case pack should not be treated as a constraint but more as an opportunity. Analyzing the localized needs, retailers need to re-negotiate case pack sizes with their vendors .
3. Space Considerations Upfront – Considering space during assortment planning can avoid challenges like poor facings and compromised assortments downstream during planograming.
4. Space Elasticity – The concept of space elasticity says that if more exposure (facings) are given to a product, its sales increase. However, it plateaus after a point. If space elasticity is not considered, SKU rationalization leaves holes in the planogram which the buyers typically fill with new items, thus eliminating the benefits of SKU rationalization (the objective being to reduce the number of SKUs). It also constraints a high-performing SKU from getting over exposure. Hence by adjusting facings, sales could potentially increase, thus justifying investments on inventory.
5. Customer Choice Set – Certain sets of SKUs, though low on performance, if not present in the store, would make customers walk out of the store empty handed. This could also incorporate loyalty data to identify which SKUs are important for your loyal customers.
6. Implications of delisting SKUs – If the retailer is high on inventory on SKUs that are delisted, marking down such SKUs would increase the costs rather than decreasing them.
To conclude, localization not only increases revenues and margins, it also helps to reduce inventory costs – Invest in what moves and cut out slow movers, of course after considering all the other parameters above.
There is a fundamental mistake in this article. “Put simply, you’re spreading the same amount of inventory over a larger number of SKU’s.” Further…the article takes as a given that localization requires greater levels of inventory.
Not so. Absolutely not so. True localization means tailoring the assortment…not layering on additional SKUs. If localization is worth the effort then it is a fact that there are some SKUs not worth maintaining in one location that are worthwhile elsewhere. The critical component to this issue is the acceptance that localization and inventory management are contradictory. Not only is this inaccurate, it misses one of the critical elements of the value proposition of localization!
By definition, if less productive SKUs or quantities of those SKUs are traded out for more productive SKUs (regardless of how many stores carry them), inventory utilization increases. Period. And that is supposed to happen with localization and assortment tailoring.
If you are a retailer and you are NOT getting improved inventory metrics from your localization/assortment tailoring program…you are doing it wrong. Period.
Perhaps I am reading the question wrong? Localization efforts and inventory discipline is the same thing. Full inventory discipline demands localization efforts.
I have told the story several times in this space. One of the big three drug chain’s inventory system was so “disciplined” that it created total inventory mis-management at the local level.
The Phoenix district of this retailer included the largely retirement area of Scottsdale and the largely college area of Tempe. The product in question sold very well in the Tempe stores and not at all in the Scottsdale stores. The Tempe stores could not stay in stock between deliveries. The Scottsdale stores had over a year’s inventory. The district manager wanted to move merchandise between the stores but was forbidden. The DM also wanted to increase the replenishment levels in the Tempe stores but was told that only the buyer could do that and only on a national basis.
Clearly, if this retailer was truly focused on inventory discipline, they would be making local (store by store) decisions that would have reduced overall inventory and increased sales.
The article (and to some extent the responses) seems to be confusing different types of “localizing”: there is a localizing of tastes/preferences (Cincy likes plaid, Philly likes stripes,etc.) where there is substitutability, and then there is a localization of size/product (the old “snowblowers in Miami” anecdote) where there is none; needless to say, the former is open to “marketing” efforts, while the latter is not. Beyond this basic point, inventory is a numbers game: is the likelihood of a sale to a fringe demographic worth the cost of stocking for that group? Clearly it depends on both the likelihood and the cost(s).
What I found interesting/disturbing in the article is the comment that someone can localize (a small) part of their inventory and “create the impression” of something more: Argh! Sad to see that many retailers are (still) more into APPEARING to offer service than actually offering it.
I’m in complete agreement with Bill Emerson. “The challenge of localization is organizational. How many merchants/planners are in the organization, where are they located, what are their reward structures, etc, etc.”
Localization is great in theory, but something very different in practice. In practice, it’s hard to envision localization being executed to exclude certain SKUs in favor of others, so assortments and inventories do grow, and it’s still not clear to me that localization leads to the net sales increase necessary to support that increase in inventory.
As I’ve written before about localization, “I very much believe that the jury is still out on localization. The fact is that certain economies of scale are inevitably lost with localization, and the benefits are unclear across the full store base of almost every chain. It seems to be a qualitative objective whose financial impact has yet to be fully quantified. Given the competitive environment we’re likely to see for the foreseeable future, every economy will be essential to meet competitive price points, and that’s something that can be quantified.”