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So we’ve covered Gross Margin (How much will I make each time I sell my Gizmos?) and Stock Turnover (How often do I make this margin when I sell my Gizmos?). Now we’ll take a look at the dynamic balance between those two metrics.
There are a number of these factorings of margin and turn that retailers use, but one of the most common is GMROI, or “Gross Margin Return on Inventory,” often confused with the “Jim Roy,” a non-alcoholic cocktail or that little known ancestor of Robert the Bruce, Jim the Roy.
As we said, this indicator is dynamic, and tends to be “The Great Equalizer,” allowing comparisons between inherently different category types. How do we compare the relative merits of a group of styles that, for example, maintains a 39-percent Gross Margin (GM) but turns at four times a year, against another group maintaining a 45-percent GM and turning twice a year? Which is better? Which one should I put my energy into?
GMROI offers us one way to level these and make a reasoned, if not imperfect, comparison.
Here’s the math:
GMROI = Annual Turns times Maintained Gross Margin (MGM), expressed as a decimal.
For our example above:
Turn x GM = GMROI
Group 1: 4.0 (Turn) x 0.39 (MGM) = 1.56 (GMROI)
Group 2: 2.0 (Turn) x 0.45 (MGM) = 0.90 (GMROI)
On the surface of things, Group 1 would appear to be a more efficient and profitable category. But Group 2 (depending on the dollar volume, the missing piece of information here) may bring you more dollars, but you’re the one who has to decide what you can afford to carry inventory-wise and if a slower turn rate (and as a result, a lower GMROI) is within your ability to finance. Generally speaking, a higher GMROI is more desirable.
Do remember these metrics are still only factors and percentages and do not by themselves indicate dollar profits. We always admonish our retailer friends: Percentages don’t go in the bank, dollars do.
At the end of the day, it’s gross profit. Dollars. Cash.
Another merchandising term that we use often, and that is sometimes misunderstood, is sell-through or sell-off percentage.
The confusion with this statistic comes when we fail to include a timeframe. We can illustrate this with an analogy:
If we say we did 100 pushups, you might be suitably impressed. So would we. We would want you to assume we did those in 30 minutes, nonstop. In actuality, we did them in 1999, one every third day, and then took a couple months to rest.
We regularly hear claims of sell-through percentages without any temporal qualifier.
“We got a 75-percent sell-through on these Super Gizmos!”
“How long did that take you?” should be the next question.
If you sold your Super Gizmos through at 75 percent in three months, you’re doing pretty well. If you took an entire six-month season, or a year, then you’re not looking so good.
Sell-through and turn and another term, stock-to-sales ratio are mathematically related.
Stock-to-sales ratio is a number you want to see going down, or getting lower. A high number here means you’re getting ready to write Uncle Chauncey an apology letter in the afterlife for messing up. To determine your stock-to-sales ratio (SSR), you divide your average inventory at cost (AIC) by your cost of sales (COS), so the formula looks like: (AIC / COS = SSR). The only thing you must remember here is to be consistent in terms of time periods being analyzed. It is NO GOOD dividing your average inventory at cost for a six-month period by your cost of sales for a three-month period.
Sell-through percentages are derived by taking your cost of sales (COS) for any given period and dividing that by your average inventory as you no doubt remember. This number wants to be going up, just as your stock-to-sales ratio is going down if your goal is to see Uncle Chauncey dancing in his grave and you smiling more broadly.
Both sell-through and stock-to-sales ratio are merely different views into the efficiency of your inventory related to your sales. They are a tool you can use to answer Uncle Chauncey’s question from the afterlife, “So, nephew, are you using your inheritance profitably?”
The chart below gives you a very simplified picture of how these factors relate to one another. For clarity, we’ll assume equivalent sales each week (a huge assumption we know):
|Annual Cost of Sales||100,000||100,000||100,000||100,000||100,000|
|Weekly Cost of Sales||1,923||1,923||1,923||1,923||1,923|
|Average Inventory at Cost||50,000||33,333||25,000||20,000||16,667|
|Weekly Stock-to-sales Ratio||26.0||17.3||13.0||10.4||8.7|
You can see that in order to maintain our $100,000 in annual cost of sales, we can use as much as $50,000 or as little as $16,667 of Chauncey’s hard earned dollars, depending on inventory efficiency or sales velocity. Even deceased, he’ll prefer the latter.
Typically, sell-through percentages are expressed in shorter periods of time than a year. Most often we may use the season, usually a six-month block of time.
If our friend who was so excited about his sell-through of Super Gizmos indeed did achieve a 75-percent sell-through in a full six-month season, as we said, he didn’t do so well. Let’s take a look at that example:
If our dealer friend could have doubled the sales velocity in this group of styles, he would have seen annualized turn rates in excess of four. That, combined with a decent margin, say of 45 percent, would produce a GMROI of 1.8 or better, a stand-up double in anyone’s books.
He may have had to mark down the last stragglers of the buy, those XXL Robin’s egg blue long-sleeve tees or the holiday gift baskets for the mountain cabin that somehow stopped selling Dec. 26, but he sold 90 percent of them at full pop and the markdown only affected the maintained gross margin negligibly, so the whole buy contributed mightily to his store’s profits.
Did we say markdowns? Isn’t that a dirty word? Not at all. They are an essential part of your merchandise planning, but that’s for next week when we look in more detail at markdowns, surplus inventory management and related topics as we continue with article No. 4 in our Retail Merchandising Training Series.
Have a question that is not answered here, or an observation, or even a better way of going about the business of retail merchandising planning than we have offered up? Then the SNEWS® Retail Merchandising Training 101 Forum is for you. Click here to enter a private chat section open only to SNEWS® subscribers.
This article is part of a 10-part Retail Merchandising Training series produced by SNEWS® and authored by Michael Hodgson and Geoff O’Keeffe. SNEWS® president Michael Hodgson, in a former life, was a manager for five years with Adventure 16 and the general manager overseeing a team of buyers and store managers for three years at Western Mountaineering. In those roles, he learned, sometimes the hard way, how to make a living and make a profit (or not) in the world of specialty retail. Geoff O’Keeffe has held retail senior management positions at Granite Stairway Mountaineering, Adventure 16, Patagonia and PlanetOutdoors.com, as well as having served as president of Lowe Alpine Systems USA and Mountainsmith. He is currently the vice president of operations at American Recreation Products, which he is managing to fit in while working on new projects at his home in the mountains above Boulder, Colo., where he is a fourth-generation resident.