Holding on to old merchandise can kill your profit margins. That's why learning about OTB, open to buy, is important when running a retail store.
Many retailers have had to deal with an excess of merchandise due to lower demand, it is still your money sitting there, and you need to cull it often.
I had a couple of roommates when I was just out of college. We shared buying the groceries, each taking a turn at buying based on need.
One day I poured a glass of fermented milk with clots and mold into a glass. My roommate's excuse? I couldn't see it.
Think of your inventory like you would fresh milk. Unless you look at it, you end up with spoiled, stained, and unsellable merch.
Selling your inventory is your only way to make money.
Yet I've seen as a retail consultant that it is one of the least understood aspects of retail for many.
Your merchandise has to come and go regularly, or it will rot.
Would you want to buy tens of gallons of milk but end up with most of it spoiled?
No, you manage fresh milk by how much you use. The same must be true of your merchandise.
If you buy too much inventory, it will go bad.
When buying merchandise, you’re certainly hopeful that it will sell; but your orders must be based on more than a hunch if you want to grow your business. That's called an open-to-buy system.
Your stock levels must correspond with your most recent sales trends. For example, you can order 10% more merchandise if sales grew 10% in the previous two months.
Here's how to figure out your open to buy:
At a very basic level, just starting with your full-price inventory divided into your total sales can give you a merchandise turn.
How to make an open-to-buy plan:
- Take a physical inventory of all your merchandise at full value. Be sure to count any returns, holds, etc.
- Run a year-end report. Divide it by 12 to determine how much you sell per month on average.
- Divide your average monthly total sales by your on-hand inventory. Some months will be higher than others so to be accurate, perform a complete store inventory at least twice a year.
An example of a basic open to buy is to take a physical inventory. Let's say it is $500,000 at retail. Take last year's total sales of $1,500,000 and divide by 12 to get your average monthly sales of $125,000. When you divide total inventory by the average month, you get the number four.
That means you have about four months' worth of on-hand inventory. That isn't good.
You normally want a merchandise turn of at least two which means in the example above, you should have no more than $250,000 at retail on your sales floor at any one time.
When you have so much unsold merchandise, you have zero open funds to buy merchandise or an open to buy of zero. In that case, and any time you are overbought, you should always look for more ways to increase merchandise turnover.
Yes, you can move on to a much more robust open-to-buy formula, but you'll need to make some assumptions about how much you'll be marking down merchandise every month, what you expect to sell through a month, and account for orders already placed.
See also, Why and How To Do A Physical Inventory On A Shoestring Budget
While looking for direction for 2020 during the pandemic, look at the last downturn in 2008 when retail giant Nordstrom decided to shrink its year-end inventory per square foot by 12% from the previous year, thereby reducing supplies in line with shrinking demand. That poised them for future growth with new merch rather than stockpiles of unsold goods like Macy’s, a store that was practically trying to give the stuff away with 70-80% off.
Don’t hold on to past failures
If it didn’t sell when it was new, don’t think it suddenly will six months later when your employees are cold to it.
It’s best to identify as quickly as possible what is not performing, move it out, and bring in fresh merchandise. That allows you to get more of the right merch to grow profits.
While that sounds simple, you’ve likely had the experience of telling your manager, “We are going to get rid of X product because it’s not selling,” and had your manager reply, “We can’t get rid of it; we sell tons of it!”
Then you went to your POS reports and found you only sold a handful. That’s because most employees remember most vividly their last sale or the last thing a customer requested that you didn’t have.
To get the big picture, you need to use your category sales report from your POS system to determine the correct inventory levels. Otherwise, you might think it being out of stock is reason enough for a reorder.
But missing stock could be due to demand or theft, customers taking it when no one is looking, or employees lifting it as they take out the trash. You’ll never know unless you look carefully at your category reports.
All of your categories should be able to be profitable. Again, shopworn merchandise is like sour milk; people avoid it.
Take aggressive markdowns now while you have shoppers coming in rather than waiting to have a clearance sale when few are entering your doors.