Inventory Optimization: Retail Strategies for Eliminating Stock-Outs and Over-Stocks

Unfortunately, apparel retailers must still mop up holiday 2008 before they can move further into 2009. Aberdeen data reveals that an astounding 70 percent of apparel retailers rate themselves average or below average on their inventory management processes.

While there were certain macroeconomic influencers beyond their control (e.g., unsteady financial markets, wildly fluctuating fuel prices and unemployment figures that haven't been seen in decades), most retailers know that they will fall well short of their sales forecasts yet are not taking any truly meaningful action to move through their excess perpetual inventory from stores and other sales channels.

As this report will demonstrate, there are best-in-class retail practices that can improve inventory-related customer satisfaction, inventory turnover and working capital that can be channeled into other areas such as product development and global expansion strategies.

Service levels and pricing pressures
The top pressure facing 60 percent of best-in-class retailers is the need to address service level imbalances at the retail shelf, or short-term product category demand. Traditional retail inventory planning that filled warehouses with advance merchandise orders to the tune of six months or more is not a sought-after strategy anymore. Speed to market is of utmost importance for apparel retailers. Due to constant changes in fashion, the shelf life of products is relatively short. Apparel retailers must get a better handle on the inventory lifecycle of their merchandise.

The second-highest inventory-related business pressure of best-in-class retailers is the need to respond to the market's expectation of reduced shelf-level prices even as customer demand varies extensively on a week-to-week basis. On the whole, apparel retailers are unable to perform a flat-out and across-the-board reduction in their prices due to the fact that manufacturers are not fulfilling their part in whittling down prices. In other words, the price war between retailers and manufacturers is at a peak.

As a result, retailers are responding through deeper and more frequent promotional discounts or markdowns in the apparel and footwear segments. This results in a slow but potentially deadly problem of "bottomline and working capital squeeze." Yet another impact point is that, as a result of the price reduction-related inflexibility of their suppliers, apparel retailers are propping up their own brand categories so that they can manage price, margin and sell-through in a much more controlled manner. These steps are an unquestionable blemish on the traditional retail-supplier bonhomie and collaboration in the areas of effective inventory planning, replenishment and shelf-level demand management. Our results show that as a response, suppliers are taking their own desperate measures and applying counter-actions such as:
* Non-compliance with retailer order cycle times and on-time delivery requirements
* Creation of new sales channels for expanding their own sphere of sales influence (e.g., online and mobile)
* Lack of retail supply chain responsiveness towards short-term demand adjustments and multi-enterprise supply chain visibility (visibility towards inventory availability and quantity for all major retail and supply chain stakeholders) that are required for agile and customer-responsive inventory management in the retail-supplier ecosystem.

Best-in-class strategies

Figure 2 below denotes that leading retailers realize that scalability and extensibility of their retail shelf-level inventory strategies is dependent on year-round consistency in their inventory order management and supplier collaboration processes. Our results signify that best-in-class retailers are 2.9 times more likely than laggard retailers and two times more likely than average retailers to improve end-to-end inventory order management through computer assisted ordering (CAO) functions in a closed-loop manner.

The closed-loop approach involves store-shelf level data sharing with buyers, procurement job roles in the retail headquarters for planning purposes through to suppliers, and a loop-back into the retail warehouses and sales channels in terms of finished product.

This is achieved by developing a far more comprehensive and detailed mapping of the inter-linkages between business events, job-role needs, and IT functions such as CAO database creation and applications that can enable seamless inventory order management utilizing shelf-level reviews and audits done at stores. As part of this inventory order management strategy, the shelf-review process in stores is critical to the success of CAO applications.

One of the critical demand-related complexities that causes inaccurate shelf-level inventory planning is the inability to sense and respond to inventory demand trends. More than half (55 percent) of apparel retailers surveyed are able to capture a demand trend in five weeks, while 44 percent of apparel retailers respond to a demand trend at a painstakingly slow rate of six weeks or more, causing all sorts of seasonal in-stock complexities for stores. The lack of inventory accuracy at stores is not only a planning issue, it is also a performance and bottom-line challenge that has a ripple effect.

Best-in-class capabilities
Leading apparel retailers with a perpetual inventory strategy managed by cross-functional teams try to ensure that products are available for a customer when they need them. Optimum availability of product in stores and channels improves customer satisfaction, inventory turnover, and margin percentage per customer visit. Less-than-adequate inventory leads to a distraught customer and dismal sales. On the other hand, more-than-adequate inventory levels (an overstock scenario) leads to lower than anticipated inventory turns, higher markdowns and high cost of goods sold.

Aberdeen's analysis of the best-in-class demonstrates that leading apparel retailers follow more comprehensive and practical approaches that enable customer-centric inventory management in retail stores/channels through a combination of:
* Store- and warehouse-level inventory tracking and audit procedure compliance for inventory accuracy.
* Perpetual inventory procedures downstream - timely field-level inventory stock-out and over-stock updates.
* Improvement of multi-store location and multi-warehouse inventory planning to ensure localized inventory for stores.

Process capabilities
Retailers within the apparel segment lack consistent process execution toward maintaining active, inactive, discontinued and clearance merchandise in stores/channels. Some of the complexities are due to in-store inventory execution shortcomings. However, a bulk of the "on-hand inventory and on-shelf availability disconnect" is due to inadequate processes at headquarters and at the warehouse level. This inadequacy leads to in-store sales and margin imbalances on a daily basis.

Aberdeen data indicates that best-in-class apparel retailers are taking the leap in managing these shelf-level inventory processes by addressing three primary areas of focus:
* Unit-level item thresholds: Best-in-class retailers are 1.5-times more likely than all other apparel retailers to establish SKU-level minimum and maximum quantity thresholds that assist in forecasting and automated replenishment. This helps in controlling out-of-stock opportunity costs for the stores. The reverse is true in the case of two-thirds of retailers currently, where slow-moving items are not selling down to a particular level due to unfavorable demand factors.
* Multi-enterprise and enterprise-wide visibility towards SKU-level availability: Visibility toward active in-store on-hand merchandise and inactive merchandise that has moved in the past seven days is imperative for creating cohesive stores, warehouses and headquarters departments (supply chain, inventory, distribution and store operations). Companies can achieve visibility by adopting browser-based inventory management systems that update quantities as close to real-time as possible and generate summary emails or dashboards.
* Optimum safety stock requirements: Best-in-class companies are 1.2-times more likely than others to develop safety stock requirements or "shock absorbers" that are optimized to work for four to eight weeks of inventory supply. Currently, 40 percent of retailers are unable to optimize safety stock requirements to a four-to-eight week level. This can lead to an inventory clog which can be removed only if apparel retailers implement higher than the 10 percent to 20 percent standard markdown practice in terms of overall inventory.

Organization capabilities

Today's perpetual or non-perpetual inventory systems in retail have one common goal: the speed to shelf. In the apparel segment, the customer does not wait. Once within the four walls of a store, it is the apparel retailer's mission not to let the customer leave without his or her desired purchase. This does highlight the growing importance of aligning on-time replenishment with store-execution management (SEM) principles in terms of the organizational structure. Best-in-class retailers are 1.2-times more likely than all others to connect SEM processes with rapid shelf-level replenishment strategies. This means that best-in-class retailers are connecting the operational dots by creating an organizational structure to:
* Respond to rapid replenishment needs by planning direct-to-store inventory deliveries (DSD) based on specific inventory unit-level needs (e.g., high-volume vs. low-volume locations), geographical location of store, and labor hours (e.g., freight break-down and shelf put-away during customer peak vs. non-peak hours).
* Enable execution of store in-stock procedures such as cycle counts, handling out-of-stock exceptions of active and sale of inactive items, and low balance walks. These procedures ensure that store inventory is updated on a daily basis for rapid replenishment.
* Manage other in-store inventory accuracy tasks based on store-labor management principles in areas of damaged goods, direct-drop shipment from suppliers, returns to vendor, returns to warehouse, markdown and clearance merchandise stock procedures.

Recommendations for success

As apparel retailers try to improve inventory management performance, many areas of improvement need to be examined and addressed. Even those retailers with successful inventory management practices can find ways to improve their processes. Below are a few key recommendations that will help steer apparel retailers in the right direction.
* Implement direct-drop shipments from suppliers.
* Set unit-level inventory thresholds for automated ordering and replenishment.
* Implement a strategy to manage store/channel-level inventory stock-out exceptions.
* Develop a collaborative planning forecasting system (CPFR).
* Make on-time replenishment collaboration a key component of store-execution management. n

Sahir Anand is research director, Retail, Hospitality and CPG, Aberdeen Group and Chris Cunnane is research associate, Retail and Hospitality, Aberdeen Group.

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