Tuesday, January 12, 2010

Inventory Controls That Work

Open-to-Buy is great for businesses with vendors who ship quickly and can pinpoint delivery with consistent terms. It works great for businesses whose monthly/weekly/daily sales are predictable. It is a super system for companies who can give the system full-time attention.

In other words, for the Independent Retailer, Open-to-Buy sucks!

I've looked at a half-dozen OTB methods, none that I could ever get to apply to my business. Too many vendors with different terms, different minimums, different seasonal needs, different availabilities. If I tried to run LEGO on an OTB, we'd be OOB (out of business). I sell it all in December, but if I don't order it to arrive in August, LEGO will be sold out and I'll get nothing.

Instead of an OTB, we followed these three simple principles this past year that gave us the results we wanted.

Don't be out-of-stock of the Must-Haves. We define Must-Haves as any product that we sell more than 36 pieces a year. You probably already know intuitively what products you sell on a regular basis that you always have to have in stock. Make sure you have enough of those items at all times. (Note: You can define your must-haves by whatever criteria you want. Just make sure you always have them.) This way, although the rest of your stock might be low, the customer always thinks your stock position is strong. The fewer times you have to say, "No, I'm sorry, we're out-of-stock," the better.

Don't out-buy your Dating Terms. If the vendor gives you 30 days to pay the invoice, don't buy more than a 60-day supply (assuming keystone or higher mark-up). Sure, sometimes this doesn't work (see the LEGO example above). Sometimes the minimum order is more than a 60-day supply. Fill your shelves with that first order, but don't re-order until you can order within the terms. And whenever possible try to get longer terms from your vendor.

Two ways to extend your terms:
  • Ask your vendor - especially if you are ordering new stuff. If you have a strong credit rating or excellent payment history ask for an extra 30 days. Remind them that it will help you to buy/try more. Then be absolutely sure to pay that bill on time.
  • Pay with a Credit Card the day the invoice is due. This give you an extra 20-30 days depending on your credit card agreement. (Make sure you pay that bill on time, too - fees and interest will kill any deals/savings you get.)
Minimum orders are Okay - Don't buy what you Don't Want. You don't always have to increase your order just to get whatever special is available. Discounts, Free Freight and Extended Dating are nice, but not always necessary. Sometimes you find yourself buying stuff you don't want or need just to qualify for the discount. After paying interest on the money you borrowed to pay the invoice, plus taking a markdown on the products you didn't want and couldn't sell, you'll find that the special wasn't so special after all.

The best specials your vendors can offer you are:
  • Extended Dating - Net 60 or Net 90 do more for your cash flow than anything else. Always select this option first if given the choice.
  • Free Freight - Depending on where they ship from, this can be as much as a 15% discount - great for the bottom line profit.
  • Deep Discounting - 5% is no incentive. 10% isn't much either. To be considered Deep you need a 15% or better discount. Don't ever over-buy your dating terms for less than 15% off (the equivalent of Free Freight). Even then, only buy what you know you will sell.
Dating does the most for your Cash Flow. Discounts & Free Freight really only help the Profit/Loss. Go after the special that meets your needs.

There will always be times when you have to over-buy. But choose them carefully. Do it for your Must-Haves. Do it when the dating terms are favorable. But if you ever find yourself thinking, "I'm not sure I really want to buy that," then don't!

We decreased our average inventory by over 10% this past year (while only losing 4% in top line sales). This caused us to have a higher Gross Margin Return on Investment (we made more money on the money we spent) and better Cash Flow. Follow those three principles and you'll see an improvement in your business, too!

-Phil

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