The importance of making the right choices

By Peter Cox August 04, 2017 Industry news

I am sure everyone has heard stories of the demise of hardware stores over the years.

Common reasons given for failures include competition pricing, consumer demand and a variety of other reasons.

But one area which is not often examined is inventory management and the type of stock in the store.

Unlike a lot of other industries where there is high degree of commonality, this is not the case in the DIY retail sector.

We have different districts, within which building activities differ and the demands of DIY customers and tradespeople vary greatly.

Even in towns, stores may have built up a reputation for building or garden supplies.

Sometimes the customer may even need to buy their other requirements from other stores.

If you don’t see high demand for the types of product the customer needs, they may not come back. This is particularly the case with the building trade.

My experience over the last 25 years is that whilst the “bottom dwellers” who shop around based on price and choose both the store and product based on this, the vast majority of clients shop on the basis of product choice and availability.

 

CHOICE IS ONE THING, BUT WHAT ABOUT STOCKTURNS?

Now we all make mistakes in anticipating what customers need – particularly if it is a new product or because one customer has requested it. (This is generally when the brain explodes and makes us order a pallet!)

What that generally leads to is the beginning of problem lines, which may mean good Gross Profit Margin but low stockturns over time.

Products which do not move I call “dogs” and I advise participants at my workshop to shoot them (figuratively speaking!).

Why? The maths are simple. I currently use what is called a Rate of Return Target for stores of 20%,

The Rate of Return reflects the Net Profit return against the investment generated.

For example:

Net Profit $50,000 (from your Profit & Loss Statement)

Assets $1,200,000

Liabilities $500,000

Owner’s Equity (Assets – Liabilities from the Balance Sheet)

$1,200,000 – $500,000 = $700,000

Rate of Return $50,000 ÷$700,000 = 7.1%

Obviously the profit is not an adequate return for the $700,000 invested.

Where are most of the dollars invested in the activity assets of business (that is, assets used on daily basis)?

Well the answer is stock.

As I mentioned I have a target of 20%.

Using this percentage you can calculate the Cost of Stock.

That is 20% ÷12 months x 12 = 1.67% per month.

Whilst the product does not move it costs 1.67% per month and the cost over 12 months is just a bit over 20%.

This cost is not reflected in the financial statements but is what is called an opportunity cost – that is, you could have bought something else, sold it and already have your profit.

But, while stock just sits there it returns nothing but a cost.

 

GIT ALONG, LITTLE “DOGGIES”

The second problem in inventory management is reluctance to mark down price to move the “dogs”.

Remember – although stock sits in-store and is reflected in the Balance Sheet as an asset, is it really an asset to the store from another perspective?

While all stock takes up space in the store, the amount of stock on the floor is also an advertisement for your business.

Trouble is, the larger your stockholding is, the harder it is to manage and the harder it is for customers to access stock.

Importantly, management and staff should be spending their time managing inventory that sells and ensuring the right inventory level so you don’t run out of what I call the “star lines” (high stockturn, high Gross Profit Margin) or the “cash cows” (lower margin but the highest stockturn).

The cash cow lines generate the bulk of the turnover.

The star lines are generally the accessory products that go with the cash cow lines. A good example is a paint brush and paint.

The trap is spending too much time in managing the “dogs” and giving them the most valuable merchandising space in the store.

Dogs enter the store through generally poor choice and they need to exit as soon as possible!

Appropriate inventory choice and management goes a long way to improve profitability and cash flow, which are the two key drivers of a hardware store’s survivability.

 


Peter Cox is a senior consultant for Macquarie Advisory Partnership based in Sydney. He has over a decade of experience training and consulting in the retail hardware industry. He conducts key-note addresses, and management and sales workshops, which are aimed at improving profitability and liquidity in one of Australasia’s most competitive retail environments. Phone 0061 438 712 200 or visit www.petermcox.com.au

 

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