How to use Inventory planning tool “Open to buy” & use it strategically?

To write this article, I was inspired by the response that my previous article got i.e. on Markdowns in retail, which got read by over 10,000 retail professionals worldwide right from Australia to the UK and of course middle eastern countries.

In continuation of my earlier blog on Markdowns topic, I would like to highlight another important inventory planning tool i.e. OTB or Open to Buy.

I get so disappointed to read Retail industry news wherein we read that classic brands across the world are either closing their stores or filing for bankruptcy & recent example is of Toys R Us. Many retailers had to close their doors because they did not manage their inventory well. One of the biggest contributing factors to mismanagement is a lack of an open-to-buy system with key retailers.

Even the Middle Eastern region is not insulated from this Retail apocalypse, in fact, gone are the days wherein local traders turned retailers used to import container loads of goods and sell at full margin. Cut short to 2018, to sell even 25% of inventory at full price is a dream come true for many retailers amidst tough competition across categories say its fashion, beauty, toys, electronics etc.

What is OTB?

An Open-To-Buy is a budget and involves the full range of budgetary functions. It begins with the planning process, is future oriented, provides guidance on how much to buy, and provides benchmarks for evaluating progress and adjusting future plans. 

Having too much inventory (or the wrong type) during certain periods can slow your cash flow and reduce profits with too many markdowns. On the other hand, if you under-buy (meaning buy too little product) and miss sales opportunities, then you are not making your potential profit (plus damaging the customer experience). A retailer can be sure to stock the right amount of the right products at the right time by using an Open-to-Buy plan. 

How to calculate OTB – its formula?

As per retail textbook, its formula is simple i.e.

EOM (end of the month stock level-desired estimate)
+ Sales (month actual)
+ Markdowns (month actual)
– BOM (beginning of month stock level-actual)
– Merchandise on order (or stock in pipeline/transit).
_______________________________
= Open-to-Buy (Dhs/ AED amount available for new purchases)

For example, a retailer has an inventory level of Dhs 150,000 on March 1st and planned Dhs152,000/- End of Month inventory for March 31st. The planned sales for the store are Dhs 78,000 with Dhs 7500 in planned markdowns. Therefore, the retailer has Dhs 87,500/- Open-To-Buy at retail. (Here there is no merchandise on order).

Now if you operate your brand at 50% margins then multiply Dhs 87500 x 50 %, you shall get OTB budget at cost i.e. Dhs 43,750/-

In other words, how much inventory can I buy without getting myself in trouble? It is also the process of planning merchandise sales and purchases.

Advantages:

OTB brings a balance to stock on hand inventory and future purchasing. This balance allows you to respond to selling trends in a timely fashion.

Since I have been personally involved in leasing management i.e. location scouting for brands that I have handled in the past and currently, I shall explain this in easier layman terms.

Consider merchandise sitting on that shelf is the tenant. Good tenants pay the rent on time by ‘turning’ or selling frequently. Bad tenants are the ones that don’t sell quickly and sit on the shelf for months. They take up valuable selling space that could and should be given to a faster moving product.

As the landlord, ask yourself how long can you afford to have non-paying tenants on your shelves before it negatively affects the total retail operation?

Good inventory control is critical to ensuring an adequate level of stock is on hand for the number of sales being generated.

My personal advice (based on my retail experience in Material resource planning with the leading Middle Eastern retailer):

a)    Before placing your Open-to-Buy plan into operation, ask yourself if each number is realistic. Does it make sense for the way you do business? Keep in mind that many of the figures in your inventory plan are only guidelines. A good rule of thumb is if your actual ending inventory is within 6-8 percent of your plan, you are doing very well.

b)    Be cautious about offers of quantity discounts or free freight if you increase the size of your order significantly over your normal purchasing levels. Most suppliers tend to offer free freight if brands commit to buying certain quantities and this is a trap as the supplier is trying to upsell his quantities to you with an incentive.

c)      Don’t hesitate to markdown slow-moving merchandise. Make the markdown instantly appealing to the customer by offering at least 25% to 40% off the retail price. The faster it is off your shelves, the faster you can bring in a better-selling product that will have a higher profit margin

In the case of fashion or seasonal merchandise, an Open-To-Buy answers the question of how much to buy, but not necessarily the question of which specific items to buy. For that, a detailed assortment plan is necessary.

How the Planning process works?

The planning process begins with building a sales plan.

Once a sales plan has been developed, the next piece of the planning process is to build an inventory plan. The question to ask is this: "How much inventory do I need at the end of each month to support the next month's sales (in some cases the ending inventory may need to support more than just one month of future sales), as well as maintain effective merchandise displays?"

From there, other things like inventory adjustments and markdowns need to be planned.

Finally, from the plans that have been developed, an inventory receipt plan can be arrived at. For any given period (month or week), the planned inventory receipts are the planned ending inventory, plus the planned sales, markdowns and inventory adjustments, less the prior month's ending inventory. Stated another way, the planned inventory receipts answers the question, "How much inventory do I need to bring in to cover my sales, markdowns and adjustments, given my planned beginning inventory, in order to end up with my planned ending inventory?"

A Practical tip from Planning expert Mr Jude Thomas, as he shares his experience with upcoming planners.

Case study:

Brand Benetton uses this statistical tool very innovatively along with their supply chain strategy.

Normally brands in the traditional/conventional way of production dyes complete cotton yarn with specific colours and then produce garments like sweatshirts, tees etc but Benetton does it differently.

Benetton dyes only certain quantities of sweatshirts, tees etc in various colours and sends to their stores, based on the sales movement of specific colour and type (tees, sweatshirts) then only they dye the complete yarn with colour that is fast moving in their stores.

My friends in retail would argue about the loss of time in getting the feedback from stores about which colour is moving fast, that’s where your smart MIS systems come to play, which can give you reports in a dashboard format.

Benetton has mastered this function of getting the feedback from the shop floor to production lines in minimal time period thus they avoid producing colours that would not sell or move thus preventing overstock at production facility stage itself.

This is what I call learning from internal systems and continuously improving your processes to optimize returns or retail dollars.

About the author:

Ritesh Mohan is a passionate retail professional with over 20 years in the retail sector, handling some of the biggest brands in beauty, fashion and fragrances retail & FMCG sector. He has been instrumental in the growth of some of the regional brands as well in Middle East region. He specializes in Retail management, Product development, Brand management, Retail Operations, Sales Management, Business Management & Empowering business owners with his wisdom & experience of around two decades in the industry. He can be reached at riteshmohan@yahoo.com

Markdowns – A strategic business tool for Inventory planning.

As most of my readers know that I am very passionate about Retail management and have been responsible for managing some of the regional brands in terms of Retail operations, Brand management, merchandising planning, Sales, Visual Merchandising.

I have always noticed that most of Retail CEOs/ CFOs often takes a downward look when it comes to “Markdowns”. I recall, my previous boss (who is also my mentor) used to give me a very awkward and nasty look every time I proposed using Markdowns as Marketing tool/ event.

My article will talk about as to how markdown planning can help retailers increase sales, improve margins and better manage product lifecycles.

It is my attempt to clear some concepts and convince senior management to adapt to this wonderful planning tool which can prove to be very effective in their Inventory Planning goals.

Markdowns are often associated with margin degradation and profit loss—and some companies believe that cutting prices for their products could negatively impact their brand image. Although inevitable, retailers have historically viewed markdowns as a necessary evil designed to help sell old or slow-moving inventory.

A) View Markdowns as a function of Price Elasticity: Matching Perceptions with Pricing.
An example of a markdown would be if you had a sweatshirt for sale that was originally priced at Dhs 100 and after one month of slow sales, you decide to markdown the sweater to 20% off, making it Dhs 80 at retail.

Although you just lost Dhs 20 of your intended markup on that sweatshirt, in return, you are also inviting more people to purchase it at a price they may prefer vis a vis the original Dhs 100 price. Since the shirt had not been selling well at Dhs100, offering a nice, mark downed price can often result in sales that would not happen otherwise. Hopefully a 20% discount will do the trick, however often you will find that you need to continue your markdown strategies based on slow sales, moving product from 20% off to 30%, 40% and more if necessary.

Most Retail CEOs and CFOs (especially organizations run by finance professionals and not by Retail mindset professionals) often confuse Markdowns with Discounts model.

A discount is a reduction in the price of an item or transaction based on the customer making the purchase. Many retailers offer discounts because they find that customers return to their store versus others because of the discount provided to them. Discount offers “Instant gratification”.

Customers often enjoy the advantages they feel that discounts often give, such as being a preferred customer and therefore getting special treatment. Some boutiques & Spas offer friends and families discounts, which benefits both the retailer and those getting the discounts. It’s a win-win on both sides.

Both a markdown and a discount can be temporary or permanent, depending on how you market them to your customers.

An example of a temporary discount would be "Get a discount equivalent to your waist size". If your waist size is 32 then avail 32% discount on your purchases.

A temporary markdown example would be if you had a one day sale, offering mark downed prices for only a specific amount of time.

A discount strategy is more Tactical whereas Markdown strategy is more organic in nature. Both should be an integral part of the marketing mix.
I recall the statement of Sir Martin Sorrell (CEO, WPP- an advertising agencies conglomerate), who once quipped, “Discounts are like bad cholesterol and Markdowns are like good cholesterol; there has to be less dependence on discounting model, instead push more brand-building efforts”.

B) Using Markdowns to control Inventory Ageing:

You can use both discounts and markdowns as part of your sales strategy to help make the most out of your inventory sell thru and ultimately, your sales goals.

Wasting your retail floor space with products that are not selling will not help you at all, so consider how markdowns and discounts may be able to work for you in your sales strategy.

C) Tie your Markdown planning with your financial plan- how much hit are you willing to take in markdowns?
A markdown plan means nothing if it’s not tied to the financial plan. Retailers should determine how much they are willing to spend on markdowns to hit their financial targets. This information ideally flows either from CFO/ CEOs while preparing budgets for next fiscal.

It’s equally as important that retailers are able to not only execute on the markdown plan once it’s in place but also monitor it in real time. This will ensure that adjustments can be made as the season progresses.

D) Determine early on which items you are willing to reduce in price over time and for how much:
It implies whether you want to run it on category or on specific collections. Monitor its sales-through rate and then decide the markdown %.

E) Managing Product lifecycles more effectively:

Smart retailers will leverage effective markdown planning to not only ensure that there is less stock left over at the end of the season but to also manage new product introductions and phase-outs.

Caution to Retailers who shy away from Markdowns strategy:

Retailers that avoid putting a markdown plan in place may experience increased cannibalization of new product lines and decreased sales.

The impact could even extend to the store level as new and old products are shoved together on store shelves or displays, resulting in cluttered and disorganized stores that even the most loyal customers will find difficult to shop in.

A Perfect example is “ Part Sale” that we find very commonly in retail stores these days in the Middle East, wherein new merchandise is being sold with that of discounted merchandise in separate enclosures or gondolas.

I would like to end my article by sharing a video wherein an industry practitioner and a successful retailer Mr Kamel Shaban, MD -Capacita brands, has offered one valuable tip to Inventory planners and Merchandise Managers as to how they can use Markdown strategy to keep “freshness of assortments” in their stores by avoiding discounting model trap.

           
In case if any of my readers, want to know & streamline Inventory planning strategy for their brand then I would be more than glad to share my ideas acquired while practising & closely following this topic.

You can reach me on riteshmohan@yahoo.com in case this topic also excites you.



About the author:
Ritesh Mohan is a passionate retail professional with over 20 years in the retail sector, handling some of the biggest brands in beauty, fashion and fragrances retail & FMCG sector. He has been instrumental in the growth of some of the regional brands as well in Middle East region. He specializes in Retail management, Product development, Brand management, Retail Operations, Sales Management, Business Management & Empowering business owners with his wisdom & experience of around two decades in the industry.