Article

Balancing the needs of customers, investors

Rigorous inventory control can keep both parties satisfied.

October 23, 2008

As I write this, the credit crunch is about to tip over into its second year. It is apparent that households on both sides of the Atlantic are now feeling the pinch brought about by a soaring cost of living, weak income growth, falling house prices and rising mortgage bills. In the UK, official retail sales figures indicate that the quantity of goods sold in June 2008 plunged by 3.9 percent, the largest monthly drop in 22 years. Retailers' expectations of future sales are now also said to be at a record low. In the US, the clampdown on credit has hit consumers hard — and retailers are feeling the effect as people have no more instant money to turn to and are now resorting to the old fashioned process of budgeting what they have, instead of spending on future income.

In the current global economic climate, it is going to be increasingly difficult to please investors. At present, consumer spending is 70 percent of GDP in the United States, up from 63 percent in the early 1980s. Not only is continued growth unlikely, but the current levels are not sustainable in the face of a recession and credit crunch. Retailers are starting to batten down the hatches for tough times. Some will not survive, however those that can grab hold of market share in preparation for better time will win the day. How? By looking after customers and shareholders. But is this possible or a pipe dream?

The customer versus shareholder divide
While retailers gamely attempt to address both sides of this problem, most have limited means and tend to disproportionately focus on one side or the other. When seeking to raise profits for shareholders, they lower inventory investment — and lower customer satisfaction in the process. As the number of unhappy customers increases, retailers will increase stock levels in a bid to pacify them. Usually the net result of this will be as much or even more inventory than the retailer began with, leading to a depressed gross margin, increased operating expenses and a negative effect on cash flow. This destructive cycle erodes both customer loyalty and profit margins.

In the past few years, retailers have tried numerous permutations to balance the customer-shareholder equation. They have reduced staff, sold off real estate and reduced the amount of inventory on hand or in the supply chain. This initially creates a boost in earnings by divesting core assets while at the same time reducing expenses with layoffs and minimal purchasing levels. This is good short-term strategy to right a sinking ship or unlock unrealized value, but can be devastating in the long term as it tends to ignore top line growth and the fickle nature of customers. The tendency to adopt whatever is hot at the time further complicates things: markdown optimization is a classic example, with everyone jumping into new technology without first considering how to reduce the need for markdowns.

Even the most experienced retailers will lean to one end of the customer-shareholder scale. This is illustrated by two US retailers: Sears and Target. When Eddie Lampert of ESL acquired Sears, shareholders were getting very little for their investment. The creation of Sears Holdings drove returns to investors by concentrating on increasing the company's value. Lampert achieved this by engaging in massive cost-cutting through staff reduction and inventory. He also sold off real estate holdings as well as Sears' credit card portfolio. While the value of the company was skyrocketing, comparative stores' sales were decreasing and, to this day, remain behind Sears' historical numbers. Putting shareholders first had cost them customers and market share.

The opposite is true of Target. When Bill Ackman of Pershing Square Capital Management purchased a stake of almost 10 percent in the retailer, he immediately tried to unlock more shareholder value by selling off its credit card business. The initial reaction of Target's board was to reject his proposal, however they recently agreed to sell off a minority stake in the cards business. While consistent growth for shareholders is one of Target's goals — and one where it has delivered — the retailer tends to lean towards customer satisfaction. Therefore it will invest in high stock levels to ensure that customers can always get what they came in for.

The battle between the interests of the shareholder and the demands of the customer exists largely because retailers have reached the limits of the inventory efficiency that can be driven through their supply chain. They cannot throw any more people at it, and there is no more time to make better decisions. Only by managing the inventory at a more micro level can efficiencies be driven - but for most retailers this cannot be achieved with the resources they have today. What is required is an integrated solution that can monitor product movements at the SKU/store level and continuously assess how best to stock each location — taking into account the impacts of lifecycle, seasonality, and localization. Also, if you are going to meet your merchandise and financial goals, you need to know that you are aligning your inventory in your stores to achieve those targets.

Still, some are doing better than others. In good economic times or during periods of high growth, few compromises are made as sales clip along, comp store growth is positive and shareholders are happy. But as the old saying goes, "success can hide a lot of sins." Today's economic environment is starting to expose retailers who have disproportionately focused only on customers or only on shareholders and is rewarding those who are fanatical about both. Can you balance the needs of shareholders and customers at the same time, all the time? The answer is decidedly "yes", but it requires a new and different way of thinking.

The retailers doing things right are using intelligent, highly reactive systems which understand the way products sell all the way down the SKU or size/color level. These systems enable retailers to quickly understand customer preferences in stock allocation processes and allocate stock according to actual store demand. In this way, full-price sales can be maximized — and margins optimized. The complexity of the inventory problem can be absorbed to create a better balance across the chain with positive impacts on both financial and merchandising objectives. The ability to be up and running in a matter of months also makes certain systems attractive looking for those retailers looking to quickly turn around their fortunes. They are designed to deliver a rapid return on investment. Some even require no new hardware and can work alongside existing systems, and they can also be phased in gradually: a retailer might start by using such a system to make decisions about the initial allocation of a certain range of SKUs in its stores, increase that to all SKUs then add in replenishment activities followed by forecasting and order planning.

The fact is there will always be some retailers who do better — for both their shareholders and their customers. By ensuring that customers get the right stock when they are ready to pay for it, and better understanding how they are buying on a micro level, the most advanced systems enable retailers to avoid overstocks and markdowns and maximize those all important margins. In a weak economy it is also more important than ever to preserve the integrity of the brand. This means avoiding frequent and unnecessary markdowns — while this might attract consumers, after a while it just confuses them. At the same time it weakens the brand that both your customers and shareholders have bought into. And when the economy does shed its gloom, the brand that remains intact will be better equipped to grab the spoils.

Mike Hrabe is co-founder and vice president of technology provider Quantum Retail.