The New Management Environment- A Few Ideas

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In 1995 I wrote a Market Watch column called “Getting in Deep Trouble.”   For those of you who might have accidentally misplaced your copies it talked, as the snowboard industry was starting its (first) consolidation, about what led companies to face survival issues and how they could save themselves. I started with the following:

“All businesses in trouble share two characteristics: denial and perseverance in the face of inescapable change. It’s easy to believe in what worked in the past, and hard to step outside our comfort zone and do things differently.”
It does look as though we have some inescapable change going on. And as difficult as that change is and will continue to be, I’d point out that issues of distribution, hard goods margins, lack of product differentiation and others existed long before the economy went south. Growing sales and free spending consumers made it easier to manage (or maybe ignore) them, but they were there.
Last year, and especially in the fourth quarter, we reacted by cutting orders, reducing expenses, and controlling inventories. That’s what you do when customer demand declines. I guess. Maybe I mean that’s the first thing you do. Some of that attention to detail would have been, and is, appropriate to all business conditions. Perhaps some businesses wouldn’t be having such a hard time if they’d been focusing on those management nuts and bolts all along. And maybe they would have had the balance sheet to take advantage of the opportunities the existing conditions present.
Now, we’re all waiting for the recession to end. And it will end, though I probably think that’s going to take a little longer to happen than some of you do. The concern I have, speaking of denial and perseverance, is that there are still some people with unrealistic expectations as to what a recovery will mean.
So I’m going to give you my perception of what the recovery may look like, what appropriate management behaviors could be if I’m right, and tie it to some interesting emails I’ve received and conversations I’ve had.
The New Normal (and Other Overused Clichés)
I’ve written some of this before, so I’ll be brief. But I’d like us all to be on the same page as far as the expected environment goes.
Growth, when it comes, will be a lot slower than we’re use to. Overall sales increases may be harder to come by, but there will be some fewer retailers and maybe fewer brands to share them. I expect consumers to continue to save. The time it will take to complete the ongoing deleveraging will be measured in years, not months. The Federal Reserve has cut interest rates as low as is possible and done everything they can to expand the money supply. Their goal is to get banks lending and people borrowing. Trouble is, banks are busy rebuilding their capital base, and consumers, having turned cautious, aren’t in a rush to borrow any more money. They’ve got to deal with the mortgages, credit card balances, and car payments they already have.
I think it gives you some good perspective to realize that what got us into trouble in the first place (excessive consumption and debt) is what some authorities seem to be hoping will get us out of trouble. I don’t think that’s going to happen. The Bush tax cuts expire in 2010 and I don’t expect them to be renewed. That’s going to take a lot of purchasing power out of the economy at just the wrong time.
Unemployment, always a lagging indicator (and worse than the number looks when you add the number of part time employed people who can’t find full time work), may be slow to decline. I’m concerned this recovery isn’t going to produce a lot of good jobs.
Well, that was cheery. Sorry. Feel free to send me lots of emails telling him I’m too negative. Hope you’re right. If you do email me out of annoyance, please tell me why you disagree with my analysis- not just that I shouldn’t write stuff like that. Hey- we’re trying to run businesses. We need the best information we can get- good or bad.
Some Things You Can Do
I wrote with enthusiasm last month about Gross Margin Return on Inventory Investment (GMROII) as a tool to help you increase those gross margin dollars and choose your inventory more carefully. I noted in that article that taking the best advantage of it required that you had and maintained quality management information systems. Last week, I asked a pretty senior manager of a major brand if they knew about GMROII. “Sure!” they said, “But our systems are so bad we can’t pull out the information we need to really take advantage of it.” That was disappointing.
Especially in a slower sales growth environment, whether you’re a retailer or a brand, there’s a lot of money on the table if you can manage your inventory and improve your inventory turns. There is some expense involved in buying the software and hardware you need to establish or upgrade your systems. But the real costs come in converting the data, training, and making maintenance of the system and its data a priority. I can’t say this strongly enough. You’ve got to have and use good systems. Please make the investment.
My online article on SIMA’s retail study and core snowboard retailers lead to an interesting exchange from a retailer whose sales were down 20% but whose profits were actually up due to better management including ruthless expense and inventory control. Not up a lot, they hastened to point out, but up nevertheless. I believe that kind of result is possible with good management practices for both retailers and brands. However, this retailer pointed out that at least part of their success was due to a level of cooperation and enthusiasm from the staff in controlling expenses that just couldn’t be sustained over the long term.
You know what else you can do? You can remember that nobody who’s a manager in this industry (or, for that matter, in any other industry) has ever managed under these conditions. In a lot of ways, we literally don’t know what to do. You know what the good news is? There are no rules. If change in the business environment is dramatic and long lasting, as I think this is, then you’ve got to blow up your preconceptions, be willing to take new approaches, and bring your entire team along with you.
There’s a limit to analysis. When I did turnarounds, we’d refer to “just working the deal.” We weren’t quite sure what the right thing to do was, or what exactly was going to happen when we took an action, but we knew that not trying some stuff and going along the way we had been was fatal. So what did we have to lose? Question your preconceptions. When Target is hiring team riders, they may need a close look.
One of the best ways I know to do that is to go talk to people you haven’t known for 20 years and who aren’t in this industry. Tell them about your problems, issues, and opportunities and see how they react. We spent way too much time talking to each other. I think that tends to reinforce our preconceptions.
Ed Seymour, the Director of Global Sales for Westbeach, emailed me about an interesting approach they are taking with some of their core retailers. As he describes it, under their Affiliate program, they don’t sell any product to certain key retailers, but end up making more money. I suppose that require some explanation.
They work with each store they have this relationship with and agree on a display and a location in the store. They train a key staff member as their brand champion and share the margin with the store after the product is sold. The store never owns the product. He didn’t tell me exactly how they split the margin.
After closeouts and the end of the season, Westbeach takes back the unsold merchandise and puts new stuff in. Stores with their own web sites can banner link to the Westbeach site. They track sales and share the margin with the store the same as if the customer had made the purchase in the store. They also give the retailer 12% of any product sold to somebody in their area directly through Westbeach’s web site.
Ed says Westbeach gets paid faster, the store is more willing to take risks with merchandise, and Westbeach knows right away when a shop starts to get in trouble.
Consignment, of course, isn’t a new idea. But it sounds like the structure Westbeach has built around it is making it more effective.
If you are uneasy from my description of the emerging economy, maybe my description of what others are doing, and what you can do, will help lift you up. You’ve got to get out of the denial and perseverance way of thinking and find the opportunities that are always out there when things change. Get out there and try some new stuff.

Gross Margin Return on Inventory Investment A Tool for Our Times

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Since last fall, as our new economic reality has evolved, I’ve had a few things to say about what to do. They’ve included building your balance sheet, controlling your inventory and other expenses, focusing on the gross profit line, looking at gross margin dollars as well as percentages, and making good use of your management accounting system, which I consider a strategic tool in this environment.

All very sage and business like stuff I’m sure you’ll agree. Trouble is, I didn’t really have a method to help you do it all. Problem solved.
Serendipitously, Cary Allington, President of ActionWatch, the collector and supplier of sophisticated, detailed retail information on what’s selling at what prices and margins in our industry sent me an article on the Gross Margin Return on Inventory Investment concept (GMROII). He was pretty excited. So was I after I’d read it.
 
The concept isn’t new. It’s valid for brands and retailers. It comes as close as I could hope to drawing together most of the ideas I’ve been talking about lately. Hopefully, you’ll read this and say, “Oh hell, I already know and do all that.” But I don’t think so. Neither does Cary, who spends a lot of time talking with retailers and brands about the data they have or want and its quality.
 
What Is It?
GMROII is a conceptually simple method for measuring which inventory items (or categories, or brands) give you your best return on your investment in that inventory. It combines gross profit with inventory turns in a way that allows you to compare the profitability of snowboards (or a particular snowboard) with, say, surf wax at the gross profit level. It’s not perfect, and we’ll discuss the caveats below, but it looks like it can be very useful.
 
Just as a refresher, inventory turn refers to how many times you have to replenish your inventory for a given level of sales over the year. It’s important because the more turns you have, the less inventory you can carry for a given level of sales. And the less chance your inventory will have to be marked down. Carrying extra inventory costs you money in lots of ways including cost of capital, overhead, and opportunity cost when you have money tied up in something that takes a long time to sell and has to be discounted instead of in fast moving, full margin inventory. 
 
The GMROII calculation itself is simple. It’s just the number of gross margin dollars you make selling a product (or category or brand) over whatever period of time you choose to measure it divided by the average inventory at cost over the same period. Typically, it’s done over a year. The result is a number (in dollars- not a percentage) that tells you how many gross margin dollars you earned for each dollar invested in inventory over the period.
 
Having calculated these numbers, what might you do with them? For the first time, you’ll be able to compare what I’ll call the inventory financial efficiency (I just made that up! Kind of like it) of any item you sell with any other item. You can also do it for a brand or a category. You can actually say, based on the example above, I’d rather sell the same amount of Item A than Item B even though one sells for $600 and the other sells for $12.00 and they are in completely unrelated categories. You can see which ones you’re wasting your time selling (or at least recognize that there’s no financial reason to be selling them). You can eliminate too much emphasis on gross profit margin, which I think you can see in the table below can be misleading. You may significantly reduce your inventory investment.
 
Below is a table supplied by ActionWatch that calculates the GMROII for a number of categories using data they collected from their panel of retail shops.

 

 

The GMROII is the number of gross margin dollars generated for each dollar of inventory you had in that category over the period of a year. If you could plan your whole business around GMROII, obviously you’d get rid of everything but long completes and just sell them. But your customers probably wouldn’t go along with that.

That shoes are at the bottom of the list isn’t a surprise, at least to me. Given all the color, sizes, and styles you have to carry the inventory investment is pretty significant. The opportunity is to calculate the GMROII for each SKU and figure out how you can change your mix to drive that shoe GMROII up.
 
I was kind of surprised to see the GMROII for accessories as far down on the list as it was. We’re all favorably disposed to accessories and think of them as a high margin, profitable product. This particular analysis suggests they aren’t quite as spiffy as we thought.
That skate hard goods all had GMROIIs higher than soft goods was kind of a surprise. I’d especially note the high values for short decks. We bitch and moan that the gross margins need to be higher, but because of the speed at which short deck inventory turns, they look pretty good in a GMROII analysis. This analysis doesn’t break out branded from shop decks. That would be interesting to see.
Notice how increasing the annual inventory turns boosts the GMROII even when the gross margin percentages are lower. You’d rather have an extra half turn on that inventory than a couple of gross margin points any day. But how many of you calculate the inventory you buy based on the dollars you have to spend and the percentage gross margin you expect to make? You can’t ignore those factors, but pretty clearly turn needs to be part of the analysis. 
 
The basic calculation for GMROII is conceptually simple as you can see. But I’m afraid it requires some work. What an inconvenience.
 
The System Thing
You won’t be doing a lot with GMROII unless you have a quality management information system. For the calculations to be meaningful, your sales history and inventory tracking have to be solid. If you want to track it by category or brand, your chart of accounts has to have been set up to aggregate the numbers. And of course this isn’t a onetime activity. You need to keep it current as product comes and goes, as credits are processed, as write downs occur. You get the picture.
 
I’ve talked about the need for good systems before. I’ve gone so far as to say you can’t get by without one- especially now. Some systems do the GMROII calculations for you. I’ve been told that these include Cam Commerce, which offers it in their Retail STAR and Retail ICE applications. Win Retail also offers it. I’m not sure which systems for brands might offer it.
 
Other Considerations
You can’t just keep the products with the highest GMROII. Total dollars generated matter and there are other reasons besides financial to stock a product. You can have products with huge GMROII that wouldn’t generate enough gross margin dollars to cover expenses (and some bottom line profit besides would be nice).
 
You have to already have been carrying a product for a period of time before you can do the calculation. If you want to conduct a GMROII analysis at the item level, it works best for items that you replenish rather than replace. If you’re out of inventory for a period of time, that will impact the value of the calculation.   In general, the longer you’ve carried the product, the better the calculation will be because the average inventory number will be more accurate. 
 
Come to think of it, for those of you who are statistically inclined, I recommend calculating the mean inventory and the standard deviation (dispersion around the mean) rather than just average inventory. That would give you a good sense of whether or not you can calculate GMROII for shorter time periods. Though I suppose you’d need to calculate it for the same period for all products to get comparable results.
 
If only because it gives a result in dollars, GMROII is not a traditional return on investment calculation and should not be confused with one. It’s a way to manage your inventory- not your whole business. But inventory is often the biggest number on your balance sheet, so managing it well pays big dividends. How might you start?
 
To take the greatest advantage of the concept, you really do need the good system and data I describe above. Just to work up some enthusiasm, assuming your system isn’t quite set up to make the calculations, get a pencil, calculator, paper and inventory and sales records going back a year. Pick, oh, I don’t know, sunglasses. Choose a brand. Or a style or color. Whatever it’s easy to get the data for.
Figure out the total gross margin dollars (after all allowances and markdowns) you earned on that product or product group over the year. Now add up the inventory at cost of the product or product group at the end of each month over the last year and divide by 12. Divide the gross margin dollars by that average inventory number and you’ve got your GMROII.
 
Next, depending on what you decided to do the first calculation on, do it again for another brand, color, or style. Now you’ve got the GMROII for two groups of products. Is the result similar? If not, why not? Was a style you ordered the most of just a dog? One brand just cooler than the other? Did the order get screwed up?
 
What adjustments should you make in your purchasing so you’re selling more of the higher GMROII stuff?
 
Now, for even more fun, do the same calculation for surf wax. Or whatever. Which should you want to be selling more of; the sunglasses or the surf wax? Bet you didn’t have a way to figure that out before.
 
It won’t be as simple or clear cut as I’m making it sound here. It will never be exactly accurate, but the more you use it, the more useful it will become. It’s clearly harder to do with seasonal merchandise and changing styles, but I think it’s worth the extra work, though the quality of your information won’t be as good.
 
Cary has put a link to the article I referred to on the ActionWatch web site. You can access it in the section called “POS Tips Links” at www.ActionWatchReports.com.   The GMROII concept is worth some of your time. There’s a bunch of money on the table.

 

 

Here’s a Chart Worth Seeing

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After my post on SIMA’s 2008 retail study yesterday, I got curious about the percentage changes quarter over quarter it implied. The Media Highlights gave me total core sales for the year and the percentage of sales in each quarter. SIMA gave me the same information for 2006. The rest of the calculations are mine and I used them to create the table below. The numbers don’t exactly add because of rounding, but that doesn’t really matter.

 

 

 

 

 

 

 

 

Fourth quarter skate/surf core sales were 17.5% lower in 2008 than in 2006. We don’t have 2007 numbers because SIMA only does the survey every other year, but I’m guessing the 2007/2008 comparison would look worse. SIMA has now told me that this information is in their full report, but I don’t have that and I’m guessing a lot of you don’t either.

I don’t think that number will surprise anybody who’s actually running a business, and I don’t believe it’s worse than other consumer related businesses. I look forward to improvement from this point on.

 

 

Blowback From the 4th Quarter; The SIMA Study and Snowboard Retailers

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I received The 2008 SIMA Retail Distribution Study (highlights only) about the same time I got yet another phone call from another snowboard focused, core retailer that had been around a long time and was in trouble. I hate those calls because these are shops that I would like to see do well.

My little accidental, informal, snowboard shop survey can’t hold a candle to SIMA’s study. But I thought there was some value in talking about them together.

 
SIMA does its study every two years. 2004 was the first year and the current one is for 2008. It’s great information. We all need more of this kind of stuff to run our businesses better.
 
The retailers surveyed “…carry either surf product alone or a combination of both surf and skate product.” No snowboard focused shops included. It focuses on stores that have been labeled as “core.” “The CORE channel includes retail operations that classify themselves as specialty, lifestyle or sporting goods stores. Core stores do not include military exchanges, company stores, and national department stores.”
 
 Total core channel retail sales are reported to have fallen 3.45% to $5.32 billion in 2008 compared to 2006. We don’t have 2007 numbers because, obviously, they only do the survey every other year. Nor do we have a quarterly breakdown of sales changes in 2008, at least not in the summary I received.
 
If we did have a quarterly breakdown, I’m guessing we might see sales increases in the first three quarters of 2008 compared to 2006, and probably to 2007, and then a big decline in the 4th quarter. Which brings me to the calls I’ve been fielding from snowboard focused core retailers.
 
Last fall represented the convergence of trends that put a lot of pressure on snowboard retailers. First, they were operating in a market that wasn’t growing (There- I said that tactfully). A lot of brands, especially larger ones, in an attempt to move inventory and make money, expanded their distribution.   Awareness of the recession hit full force and consumers stopped spending. Meanwhile, discounted product was all over the internet and finding that product got easier and easier.
 
Snowboard retailers found they couldn’t hold prices almost from the day their preseason orders arrived. In a one season business, where most of the product (even a lot of the apparel) is useful mostly when actually participating in the sport, and participation is expensive at a time when consumers are cutting back, it was a perfect storm.
 
The SIMA report says that core skate and snow retailers didn’t have near as hard a time as core snow shops did, though I think maybe the press release headline, “Surf Industry Riding Out the Economic Storm” overstates the case a bit. I suppose that’s SIMA’s job. Certainly skate and surf retailers are better off than snow. Their categories are in better overall shape, they aren’t as dramatically seasonal, and lots more people need an attractive, comfortable shoe than need an attractive, comfortable snowboard boot.
 
But I wish we had some comparative fourth quarter numbers. Certainly there were over inventoried issue for skate and surf just like for snow. I wouldn’t call those issues easy to manage, but they are easier than in snow where if you don’t sell it, you have to practically give it away or keep it until next year.
 
SIMA includes a table that shows product mix contribution to retail sales for the three years the study has been done- 2004, 2006, and 2008. The two largest categories, each about $1.1 billion in core retail sales out of a total of $5.32 billion, are Surf/Skate Shoes and Surf/Skate Men’s Apparel. Third at about $1 billion was Surf/Skate Equipment, down 4.5% since 2006. There are a total of 13 categories, of which only five were up between 2006 and 2008.
 
 My point is that the 4th quarter of 2008 wasn’t just the worst quarter most of us have ever seen. It was the fulcrum of change from the old to the new economy. I’ve been writing that for a while, so I don’t suppose I need to go into detail again.
 
The one good thing that may come out of all this is that I can imagine some product shortages this fall and during the holiday season. Doing what they “perceive to be in their own best interest in the short term” retailers have cut orders and manufacturers have cut production. I know that doesn’t sound good, but read on.
 
Most everybody in this industry who sells stuff has suffered from over distribution. It turns products into commodities and reduces gross profits. It occurs because all companies, in their competitive zeal for more sales, do what they “perceive to be in their own best interest in the short term.” But at this stage in our industry’s development, it turns out not to be in anybody’s best interest.
So for a change, everybody dong what they “perceive to be in their own best interest in the short term” may turn out to work for the industry though obviously not for individual companies. Unless of course, they are managed very, very well.
 
The consumer may find that the product they want isn’t 20% off and isn’t available everywhere. They may find that if they don’t buy it now, they won’t see it. They might actually start to see more of our products as special again, and worth having even at a higher price. Retailers and brands alike will of course tear their hair out when they find they have a hot product they can’t get any more of. But as they’ve adjusted to this new economy, they’ve probably started to manage for gross margin dollars and not just for sales. They might find that the adjustments to their operating structure they’ve made leaves them with more net income even with lower sales. 

Or maybe I’m just dreaming. I guess we’ll find out.