Purchase too much inventory and you're stuck with lost profits; too little, and you're out of stock. You're going to lose out if a customer has to look elsewhere for the item.
Everyone joked when Starbucks opened several new shops around existing locations. Their reason for doing so, however, was that they knew that 90% of Americans drink their coffee by 11 am; and that each person standing in front of one of their customers was a minute wait.
If someone looking to get a cup of coffee opened the door to Starbucks and encountered a line of 20 people, they would probably opt not to wait. When they left and saw another Starbucks, however, the company still captured the sale because the inventory was available. They knew their customers; Starbucks did not want to be out of stock.
In his book, Retail: the Art & Science (2004) author Daniel Moe suggests that retailers organize their merchandise into four major roles: primary business drivers, traffic builders, profit generators, impulse/add-ons. That way, you know the role each product will have in contributing to your sales and based on inventory turnover rate, how much you can expect to gain by keeping your turnover rate high.
For a grocery store, it might something look like:
Primary Business Driver (Your main category)
Staples like milk, eggs, flour and meats
Traffic Driver (brings them in)
Soda, milk, diapers
Deli, meal replacement, bakery, etc
For a bookstore, it might be
Primary Business Driver
Hardcovers, best sellers, paperbacks
New releases, Coffee houses
Coffee table books, bargain books, DVDs
Book marks, cards, stationary, gift-wrap
By organizing your merchandise into categories, you can be sure you have filled the roles necessary to be profitable.
What is the merchandise turnover formula?
The inventory turnover ratio is calculated by dividing the cost of goods sold for a period by the average inventory for that period.
1. Keep your best-sellers in stock. Find the top five sellers within each category every week, and balance total inventory to outstanding orders.
2. Before buying anything, make sure you know what it will replace. Impulse is for customers, not store buyers. Also calculate inventory turnover ratio before you give a purchase order to suppliers.
3. Create an optimal level of merchandise based on your POS reports, your merchandise turn and profitability; then create your open to buy and buy to fill. This is often referred to number of days sales of inventory; then create your open to buy, calculate inventory, and buy to fill. This can be tricky if a category has very high and/or low-priced items; so in that case, split the category.
4. Watch your expected delivery dates. If you ordered merchandise meant to go together, remember to keep it together. You don’t want its first appearance to be diluted. Later, the few items that may be left can be grouped with new arrivals to give them a new look. For example, if you ordered holiday candles from one vendor, mugs from another, and teas from another, wait for them all to arrive. It may crimp your cash flow but don't put the candles out first by themselves and lose the potential add-on sale. In those circumstances, simply taking a digital picture when you purchase them will serve as a reminder.
5. Have a pricing strategy. It's great to think of gross profit or gross margin but you have to be looking at total inventory cost which includes markdowns you'll have to take to clear when demand falls.
And don't forget the most important thing when trying to look at inventory optimization, you have to sell what you have. Train your employees better, bundle products, and monitor sales volumes weekly to avoid markdowns.