The goal of retail is to make money selling products. In the November issue, we outlined the two basic measurements many of us are familiar with: margins and inventory turns.
Today, we do the calculation that determines whether your inventory is making money and really working for you instead of you working for it.
A word before we start crunching numbers and ideas; If you missed the first segment, go back and read the November article for a better understanding of the basic ratios that contribute to Gross Margin Return on Inventory Investment (GMROII).
A garden center is comprised of many diverse product lines that have to be managed in different ways. As a result, category margins and inventory turns are about as varied as any retailer can imagine.
The mixture of perishable and non-perishable products means different expectations of attainment when the annual numbers are analyzed. And while we know margins and inventory turns are both very important to success, comparing trees to hardgoods with either ratio is just not a like comparison.
But what if we could calculate a return on investment that was an apples-to-apples comparison so we could compare trees to hardgoods to annuals to giftware to any other category? And what if it was a measurement that was easy to understand and would provide direction as to how to improve our inventory management and mix?
That calculation exists in the form of GMROII. The way I like to explain GMROII is it is a combination of margins and turns that shows how many dollars you receive for each inventory dollar invested. The formula for GMROII is:
Margin Dollars / Average Inventory at Cost = GMROII
Margin dollars are the result of the sales less cost of goods sold. This is the total amount we received by selling our product, taking into account beginning inventory, purchases, ending inventory, discounting and shrink. All-inclusive, nothing else to be considered. This is our return for selling our product.
Average inventory at cost is the “turns” portion of the equation. It is the amount of inventory we had on hand over an average of 12 months. In other words, it is our inventory investment.
If we take our return for selling our product (margin dollars) and divide it by the inventory investment (average inventory at cost), we have the ratio of dollars received for every dollar of investment. Put in simpler terms, we put a dollar in and received X number of dollars back.
In this way, comparing trees to concrete statuary or poinsettias to giftware is pretty easy. The higher dollar return, the better performing that category is over the other(s). We could just rank the categories by GMROII and declare the winner, and the whole process could end here. But we have to take it one step further and examine what constitutes an acceptable, or profitable, GMROII amount.
GMROII To Get To Profitability
To begin with, let’s analyze what the GMROII value means in relation to our expenses.
If we invest $1 and our return (GMROII) is $1, we have recovered the cost of our inventory. If we receive $1.56 back, we have covered our inventory and wage and wage benefits. If the return is $2 inventory, wage and wage benefits, and operating expenses are paid for.
At above $2 we are theoretically profitable. I say theoretically because we all know some categories are more costly in wages and operating expenses, and some are less costly.
Unfortunately, due to crossover in labor and expenses, only very large garden centers are able to separate those expenses by category to more closely determine an appropriate GMROII. For all garden centers I work with below $10 million in annual revenues, we accept the $2 benchmark and move on.
So the “break-even” number for GMROII is $2, and anything above that is even better. In that way, we would first of all say the real criteria is to get to at least $2 GMROII, or more if we can. The second question is how much more than $2 can we attain?
To determine that, we have to go back to the ratios that contribute to GMROII – margins and turns. The only way to improve GMROII is to either increase margin dollars or lower average inventory at cost. Which is easier? That depends upon the category, but let’s use a sample category of shrubs in a GMROII calculator and look at two different scenarios.
In the first, we are going to assume margin dollars for the past period at $68,000 (roughly $124,000 in sales at a 55 percent margin percentage) and an average inventory at cost of $42,000.
The resultant GMROII is $1.62, below the $2 standard we established earlier. (See Chart 1 above). Let’s lay out a plan for increasing the margin dollars next year so that shrubs are an acceptable return on investment. In that case, it looks like this:
The game plan then is to increase margin dollars by at least $16,001, which, using the 55 percent planned margin percentage, represents an increase in sales of about $29,000. (See Chart 2 above). That means an increase in shrub sales of 23 percent. And that’s just to get it to the threshold of profitability! That’s a pretty lofty goal for any garden center owner or manager.
Now Try It With Reduced Inventory
Let’s see what it takes in reduced inventory levels to reach a GMROII of $2. In this example, we are going to keep the same margin dollars and reduce the average inventory at cost.
In this case, it took a reduction of $8,001 to reach $2, a 20 percent reduction in inventory value. (See Chart 3 above). So ask yourself this question: is it possible to increase sales by $29,000 while holding the inventory at the present level, or is it easier to reduce inventory by $8,001 with the same amount of sales? In any economy, and especially now, I firmly believe reducing inventory is the answer.
Can you reduce inventory? Think about your own garden center. How many items do you have that have been there for a year – or more. You’re not alone. From my experience, garden centers are vastly over-inventoried for their sales.
The bottom 60 percent of items usually contributes only 10 percent of margin dollars in that category. That is certainly a very disproportionate number.
Think about the wasted wage and wage benefits and operating expenses exhausted on excess inventory that is dragging down performance in all areas of the profit and loss statement. Reducing inventory – and the resultant increase in inventory turns – is the place to start if you want to make your inventory dollar work for you.
At this point, a word of caution is in order. Do not reduce your inventory so much that it affects sales. While the old saying “You can’t sell from an empty cart” is true, you do have to strike a balance between what is too much and what is not enough.
Keep in mind it usually takes a garden center two to three years before it can truly bring inventory down to an acceptable level. And only through planned budgets and good use of your point-of-sale system will you even begin to make it happen in that amount of time. Time to get started!
Last month I asked you to gather the data you needed to calculate your GMROII for the categories you carry in your center. Now you can put that data to work. After you have measured your category performance in GMROII for 2010, use those numbers to compare yourself on an annual basis. Internal benchmarking is the beginning point for managing your garden center financial ratios.