Posted in Management, Marketing, Productivity, Retail Operations

The essential relationship in retail

Seth Godin has written another best seller – Linchpin – and this post has nothing to do with his ideas. Except that I want to poach his idea of a ‘linchpin’ as some a small but essential/ indispensable item.

I was thinking about linchpin in the context of learning about retail/ marketing. (I am a retail trainer by trade after all.) I started a Master of Retail class at University of Wollongong as an adjunct lecturer – my way of giving back – and afterwards I was thinking about whether I was getting the real essentials across – hence the thoughts about knowledge linchpin.

I must digress slightly to contextualise what I would like to say and ask, but stay with me.

Humans have an amazing capacity to create heuristics to make sense of a complex environment. And whilst this is necessary to cope with a flood of information, it stands to reason that much is missed – and that often includes very important ‘facts’. And it is not necessarily a positive thing.

I have always been quiet amazed how people can reduce vast amounts of information to a bite-sized ‘infobyte’. For instance after listening to a 2-hour research presentation, people will latch onto less than a handful of ‘factoids’ which will shape the marketing strategy from there on.

And I wonder if (for instance) our prejudices can’t be attributed to the fact that we create complete mental models based on snippets of perception, heavily filtered by our culture and society – which are almost invariably wrong, but form the basis of our worldview nevertheless.

People generally create these heuristics to help them function and people build their entire approach to life (and work) on such knowledge fragments. The fact that happens is indisputable – and well documented by such luminaries as Cialdini (Science of Influence)

Back to retail knowledge:

Some of these knowledge fragments would have validity, and others would simply be preconceived ideas disguised as experience. [So many people who think they have 20 years experience actually have 1 year’s experience 20 x over.]

This post is about those facts about the retail system that are undeniable; the true linchpins of knowledge as they pertain to the practice of retailing.

What would YOU consider to be a small, seemingly insignificant, but absolutely indispensible piece of knowledge about the practice of retail?

In my mind there are a few such linchpin insights about retailing upon which the entire body of retail knowledge must rest –and should this ever be disproven or changed, it would completely change our understanding

This was a very long-winded way to get around to this simple question:

Which retail insight is THE most valuable and useful for someone in retailing to know?

In my view there are a few such snippets. I will address two of these in another post (Retailing 101). But this principle is right up there:

There is a FIXED relationship between Sales (revenue) and Stock (inventory).

(By fixed I mean ‘relatively’ fixed, since there are individual differences, but that within a range this holds true if all other things are held equal – ceteris paribus.)

That is:

The ratio [stock: sales] is (for a certain category, ceteris paribus) always the same.

So, the stockturn for a jeweller is around 2x per annum. The stockturn for a ladies fashion store is 4-6. And so forth. (This list is a bit dated, but serves to illustrate the point.)

In practice this means that when a store is underperforming, the first metric you should consider is this ratio.

If the ratio is within range (on benchmark) then your only strategic option is to increase your inventory holding. This is the only way to increase sales and in fact it is a PRE-REQUISITE for increased revenue. Because of the fixed nature of the relationship (you can’t increase the stockturn if it is in range) therefore the ONLY option you have is increase the stockholding.

The opposite is true as well of course. If the ratio is too low, then you have to reduce your stockholding or figure out a way to increase the rate of sale. In this case the rate can be increased (through marketing etc), whereas in the first scenario, when the stockturn is on target, you CAN’T increase it further (all things being equal, and certainly not sustainably).

This ONE piece of knowledge (the relationship between stock and sales) is powerful and understanding it makes your strategic and operational decisions simple.

I know so many retailers who don’t understand this, needlessly spinning their wheels with promotions and discounts when it is not the solution.

[Of course you can also increase sales by increasing prices, but I assume that the merchandise is already optimally priced – and if a price increase is a viable option, then you would have taken it already. This is a subject for another post…]

  • I wonder if you agree?
  • Do you have your own ‘linchpin’ insight?
  • Are you willing to share?

 

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8 thoughts on “The essential relationship in retail

  1. This does not make sense. You are saying if I have 10 of an item in stock and say I sell 1 a week. If I increase stock to 20 units I’ll miraculously sell 2 a week???

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  2. No Dan. I am saying that: All things being equal, your rate of sale is fixed. That is for a givenb product/category there is a rate of sale. Eg. for fashion it is seasonal, for a deli it is weekly (on average). So the only way to get an increase in sales is to increase your stock. BUT of course if your rate of sale (stockturn) declines, it simply means you are now ‘over stock’. And the only way to get your raqte of sale back up to where it should be, is to promote/discount etc.

    What I am saying is that you can’t expect your sales to go UP, unless you carry more stock – and that additional stock must continue to sell at the same rate as before.

    The problem is that retailers are turning the stock at the benchmark/ normal rate (i.e. 1 unit a week) but expect to increase sales through promotion – without the concomitant increase of stock.

    Hope that makes more sense?
    Cheers

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  3. Thanks for that Dennis – I read and re-read the article until I understood it. And I now have a newfound respect for stock turns now.

    I haven’t read Linchpin, but in terms of making sense of complex environments, the theory of constraints or “The Goal” by Goldratt makes for a very interesting read (if you aren’t familiar with his material already).

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  4. Thanks 😉
    Yep have read Goldratt (my MBA was on systems thinking) and I was very much a fan.

    BTW: Stock: Sales ratio is the same thing in essence as stockturns, and may be easier to understand.
    Sorry you had to re-read this, I should have polished it more…

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  5. G’day Dennis,

    When you say “In practice this means that when a store is underperforming”, by what criteria do you mean underperforming. The way that I read the post it sounds like you are saying that stock turns are the criteria (the next sentence mentions benchmark).

    But how do you define the optimum stock turn for a given business? The list you link to is pretty simple and not all businesses fall neatly into one of those groupings. Especially if it is a mixed business with some clothing, some hardware, etc.

    Cheers,

    Liam

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  6. Hi Liam
    If you apply category management, then every category is managed as its own ‘business unit’ – so the benchmarks of ANY KPI apply to a category and not necessarily to the whole store.

    Stockturns are KPIs just like any other and are benchmarked against industry standards (see list).

    If a store does not meet the stockturn benchmark it is under-performing. But importantly it is under-performing on the most fundamental criterion. If your electricity costs are too high, it is unlikely to send you broke. (Similarly if your NP is too low, you have an issue, but that MAY be symptomatic of fairly minor problems – or not.)

    BUT If your stockturn rate is too low (usual) it is an indicator of a fundamental problem.

    The point of this article is that this KPI is a ‘linchpin’ KPI if I can borrow Seth Godin’s word.

    Hope you are well

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  7. Thanks for that, makes much more sense now.

    One way that I would look at this differently than you’ve presented is to also use historical data to monitor the current health of a store/category. Rather than use it “when a store is underperforming” (to pick on that sentence again). It doesn’t make sense to me to wait until you’re in a position you don’t want to be in before you start using these KPIs.

    e.g. if I saw that stockturns in a store were trending in a certain direction and the store is trying to achieve sales targets then I would have a much better basis to decide whether I should change inventory holding or promotional/advertising efforts and which direction to move them in to continue meeting these sales targets.

    The reason I mention this is that sometimes a business may be performing to budget and everyone is happy but there may be a problem setting budgets that masks a poor performing business.

    One aspect that I’m not sold on is the use of industry benchmarks. They are a useful measure but I wouldn’t be confident that if I had a stockturn of say 3.5 and the industry benchmark said that I should have 4.0 that the store is necessarily turning stock over too slowly. Sure, if it was 2.5 I would change the way I was doing things but my gut feel is that these are ballpark figures rather than exact targets to aim for. (any references to give me more than a gut feel?)

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  8. You are right about NOT waiting – that is a given as far as I am concerned.
    I refer to underperperfoming only because the first thing you should look at when it is the case, is stock:sales ratios. (turns)

    Product categories have an inherent stockturn:
    Newspapers = 365 (days)
    Fashion = 4 (seasons)

    Other products have less obvious drivers, but they do ’emerge’ over time if you pool enough data. E.g. Jewellery is around 2x, can’t tell you why, it just is.

    Good retailers can squeeze those turns – up to a point.
    Dept stores will have fashio categories <4, but specialty chains with good systems (e.g Sportsgirl etc) will achieve around 6-7. Of course someone like Zara have much higher turns but it is a different business model altogether really.

    The industry ave is a good starting point though.

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