In the prior issue we laid the foundation for what we expect from our business for the risks taken. Let’s proceed to discuss the ways of insuring a healthy profit in every business cycle, maybe not a 25% return on capital every year but more than that in good years to offset less than 25% in poor years.
There are a limited number of options that can be taken to achieve profitability during years when sales drop. Most retailers are frugal and watch their expenses carefully. They are thwarted in their effort because so many expenses incurred operating a retail store are fixed or semi-fixed. Among the significant ones are rent, utilities and taxes.
Among the variable expenses are advertising, payroll (and related taxes and benefits) and inventory.
Much has been written about managing advertising expenditures. Theoretically, advertising should be increased when sales fall in an effort to boost sales. My experience indicates that unless you are willing to advertise ‘sales’ or price cuts this is usually not productive. The resulting loss of gross margin dollars is not worth the sacrifice. (Unless you can buy it for less, i.e. Wal*Mart, you better not be eager to sell it for less). The long term effect of creating a ‘sale’ image for the store will be to make it increasingly more difficult to sell merchandise at full price. It has been my observation that the most profitable retailers spend between 2.0% and 2.5% of their sales on advertising. To spend more is not productive and is a cover for poor salesmanship, poor merchandise selection, or both.
The most productive form of advertising for the independent specialty store is that which will create an ongoing business relationship with the customer. The cost of getting a customer back in the store is a fraction of attracting new customers. Certainly, an effort must be made to identify and contact new customers. This can be done more effectively with a pin-point, perfectly aimed shot rather than a shot in the dark, which is what most media advertising represents. There simply is no way the independent can compete for attention in print or aired media. The full page ads, full color multi-page circulars and spots being aired on the quarter-hour used by the chains simply will overwhelm the budget most independents can afford. There are exceptions, and one or two come to mind but they are rare. I am sure you have noticed most print and aired media is of a promotional nature; advertising either lower prices or extended-payment terms.
The best solution available today to counter this dilemma is to use a carefully maintained customer data marketing base to enhance the business relationship I referred to. The sales staff should be the primary conduit supported by direct mail. A carefully conceived and executed three pronged attack using:
1. a computerized customer marketing data base
2. the sales staff utilizing the telephone
3. direct mail and e-mail which cost far less than print or aired media and are more effective
As icing on the cake, this approach enables the independent retailer to stand out from the crowd of mass merchandisers.
Payroll is usually the second highest expense incurred by a retail business. Again, most retailers are very careful with their payroll dollars. Unlike many businesses, payroll for the retailer is pretty much a fixed expense. (Payroll as used here does not include any labor associated with altering sold merchandise). Payroll should not exceed 18% of sales. That includes all bonuses, commissions and owner compensation. (That would also exclude any year-end distribution the owner might take to transfer income tax liability from the business to themselves personally). This article is addressed to those stores that rely on personal salesmanship and personal relationships with their customers. Accordingly, the largest part of payroll, that of compensating sales staff, should be based on commissions which makes it a somewhat variable expense.
That brings us to the last and greatest opportunity to be profitable during a ‘down’ business cycle. Fortunately, these ‘down’ business cycles are getting shorter and shorter as governments and economists learn more precisely how to anticipate and manage the global economy.
I estimate the cost of owning inventory to approximate 25% of sales. This includes the cost of buying, insuring, freight, interest carrying cost and mark downs to sell off the excess. It is by far the largest expense retailers have to bear. These costs are buried in almost every expense that appears on the Income Statement. The expense I am referring to does not include the invoiced cost of the merchandise. Have you noticed how unwilling bankers are to lend money using inventory as collateral? It seems only the retailer thinks their inventory has value.
Detailing the method of controlling inventory is not difficult. The method involves disciplined planning and execution. The planning involves some sound judgment and experience planning sales up to six months in advance, planning the levels of inventory to be carried and planning markdowns. The result must be reduced to writing in the form of an open-to-buy. All of this must be done at the individual merchandise classification level.
I have never understood the reluctance of retailers to plan their future and state their goals in writing. I have been asked many times “how am I to know how much we can expect to sell?” to which I respond “if not, how can you know how much to buy?” I have never understood why it is easier to write purchase orders (some of which later must be canceled, if possible) and agonize over paying bills on time than it is to plan sales, markdowns and inventory levels. I contend that a well-conceived and executed open-to-buy is a self-fulfilling prophecy. Plan it well, execute it well, and you will be a long way toward making it happen. The cost of disposing of excess inventory, forsaking gross margin percent and creating a ‘sale’ image for the store, have a long lasting, negative impact on the store.
To be profitable in every business cycle, the retailer must break the cycle of having to clear out excess inventory at the end of every season to get the funds to pay for last season’s buying so vendors will ship merchandise for next season.
I have recommended the road to year in and year out profitability. You better take or find a path of your own. The job market for someone who has failed in their own business is lean. Why would someone else want to hire you when you weren’t willing or able to make sufficient commitment to prosper in your own business?
Gerald H. Smith is a retired Retail Industry Consultant.
