Part 3

By Bill Scott

ALL OF THE calculations in Parts 1 and 2 of this article are child’s play for any computer, but there is great value in understanding the process, because there are quite a few factors that will bend the results according to your specific environment.

Every inert object has a common state, regardless of whether it is a fountain pen or an intercontinental ballistic missile. Left on its own it just sits there, taking up space and costing its owners money. I can just about guarantee if you are a retailer, seven out of every ten products in your store(s) are ripping you off. And if you are anything like every other retailer, you have developed a blind-eye to this situation and are instrumental in sustaining the status-quo.

In order to cause your inventory to generate cash, some action must occur in order to make that happen; else, it’s like your unemployed brother-in-law that comes to visit for a weekend and never leaves.

As a result, in a metaphorical sense, we might consider our inventory as having a mind of its own, merely because its performance is affected by an action applied by you, by itself, and by everything around it; else, why would we have heard the expression, “It’s a good seller,” or “It’s costing us money.”

Here’s a little excise to drive home my point:

Imagine you are the manager of a vast manufacturing plant making ‘widgets’.

For those of you who do not know what a ‘widget’ is, a ‘widget’ is a word to identify a product, when the product itself is of no importance to the discussion.

Let’s say, in your make-believe plant there are 300 disparate machines pumping out widgets by the truckload. The more widgets you make, the more widgets you can sell, and the more profit you will earn (hopefully). The machines are painted green, orange, or red, and grouped according to colors without regards to their functions. Got the picture?

Fig 1 represents a birds eye-view of our plant. There are 300 machines represented. 100 machines of each color.

 

Figure 1

 

Now let’s take it a step further and say that you have three maintenance people (one for the green machines, one for the orange machines, and one for the red machines) who are employed in the business of keeping these widget machines operational. All 300 widget machines are basically identical, but the machines vary in value by their ability to produce a certain number of widgets each year.

Now, it’s a given that due to the nature of these machines, we accept the ‘fact’ that 30-45 (10-15%) of these machines are always out-of-service. Some may be waiting for a part, others may be unplugged from their power source, and even a few may be completely destroyed and in need of total replacement.

So, we will remove the color of those dead machines, and what remains are the machines that are even capable of making widgets—the profitable, marginally profitable, and the unprofitable machines that exist in each color. A certain percentage of the machines remaining may actually be costing you money, because they cost more to run than the profits made from their actions.

Fig 2a – Dead machines in white

In addition, 165-180 (55-60%) of these machines are barely making enough widgets to pay for the maintenance they require or the electricity they use. Their primary job is to give the boss the impression that they are doing something.

 

Fig 3a – Remaining machines that seem to be making a profit.

That leaves only 90 machines, 30% of the machines that are earning all of your profits and paying for the losses of the other 70% of dead, dying, or questionable machines, resulting in an acceptable overall net profit in the single digits. How do we know this number is acceptable? Because, that’s what the industry considers to be the standard and there is nothing you can do about it. Can you see the problem here?

The question is: as the plant manager in this scenario, what steps would you take to increase the production of widgets in this factory?

 

Concentrate on pushing the 30% that are performing well, perform even better?

Repair or replace the 55-60% whose performance is ambiguous?

Toss the 10-15% of dead and unrepairable machines into the dumpster?

All of the above?

Accept the fact that this is the way it is and there is nothing economically that can be done to remedy the situation.

The correct answer should be ‘D. All of the above’, because in this exercise we are looking at each machine as a producer, and not “those machines that are green, those that are orange, and those that are red,” with the colors having no bearing on their performance whatsoever. But in the retail industry, too many conveniences store operators will choose ‘E. Accept the situation as normal and try to make the best of what they have’.

Moving away from machines at our mythical plant, we can bring the picture into a retail perspective by assuming that each color represents a different category (three in all).

Now let’s look back at Fig 3 (I have copied it here so you don’t have to scroll up)

Fig 3b

In a Category Management environment, each of the three categories might represent Cigarettes, Non-Alcoholic Beverages, Snacks, HBA, etc. By looking at the categories (a.k.a. departments), we can see that the red and green categories are producing about the same in sales, profit, cost, or whatever you happen to be looking at, at the moment.

Looking at the orange category it is easy to see that there could be some improvement there. But, what can you do about it? Nothing in this picture tells you what the products are. Getting out your Category Management rule book, you ascertain that the product mix in the orange category seems to be okay, but that’s about the extent of it. It does not tell us why the orange category is lacking in performance,

In order to drill down to the reasons for poor performance, we need to look at the products. Let’s go to Fig 2b (below) to see if we can find a solution.

Fig 2b

The white boxes in the orange category represents the dead products. They can usually be determined by the amount of dirt and grime that covers them. Note: A neat trick I have heard about is to put a small ‘x’ in an inconspicuous area of the product and check it each week to see if it is still there. But that’s a lot of work and I’m sure we can find an better solution.

The rest of the items may have problems of their own. One of the greatest being the tremendous amount of stock you need to invest in to maintain customer-service-level. Our goal should be to sell the inventory we buy before the bill comes due, leading to a quasi-consigned inventory environment where you have little or nothing invested in stock at all and still maintain customer-service-level in a cleaner more efficient environment.

How would you like to put 63% of your investment in inventory back into your bank account? If you had $4 Million invested in stock, that would be a big payday for you, wouldn’t it? Money that could be used to pay off debt, hire employees, take a vacation, send your kids to the finest universities, or to grow and expand and give your competitors a run for their money. You’ll need more than Category Management to do that, and I can show you how. All it takes is an open mind and a commitment on your part to making it happen.

To summarize this chapter, it should be obvious to you by now that Category Management can get you so far, but we quickly come to a dead-end and can go no further. In the past years, when profit margins were greater, the convenience store business was simpler, and competition was smaller, we did alright managing our inventory in this way; but it’s a uphill struggle. However, if we continue on this path indefinitely, sooner or later we will have climbed a hill too high, and there is no way to go but down.

In Part 4, we will discuss how we can use new technology that will incorporate Category Management with Item Level Inventory Control to get a clearer picture of what we have to do to succeed in our new environment.

(To be continued)