Inventory Risk and Inventory Management; Our Own Version of Musical Chairs?
Janet Freeman, owner of the small but well established women’s snowboard apparel brand Betty Rides, has a problem. On October 17th, she told me, “It’s weird but Betty Rides has ALREADY been getting lots of re-orders for snowboard jackets and pants. We cut to order, and are sold out on most things.”
Naturally, I was sympathetic to her terrible problem and said, “Which means that you are holding margins, selling through at good margins at retail, creating demand without running a big promotional campaign, being important to your retailers, and minimizing your (and the retailer’s) inventory risk? I predicted some products shortages a while ago and I think, for the industry overall, it’s a great thing. I think you are also seeing that small retailers are dependent more than ever on small brands that have not blown up their distribution and on which they can make good money.”
Better ringing your hands over sales you missed then inventory you can’t sell. Of course, I recommended this strategy for smaller brands especially years ago but, for some reason, it’s suddenly gotten popular. You can track the article down on my web site if you want.
What’s Inventory Risk?
I imagine most of you don’t need that question answered, but there are a few points I want to make and that seems like as good a subheading as any. Mathematically, I suppose your total inventory risk is the cost of everything you purchase or make for resale. If you want to eliminate that risk, you don’t make or buy anything. But that seems a little extreme. Instead, let’s define inventory risk as the potential decline in the value of your inventory from what you expect it to be; from the anticipated selling price, that is. Once you sell it, it’s no longer inventory risk. It’s credit risk if you weren’t paid before you ship it. Retailers, of course, are typically paid before “shipping.”
Inventory risk gets managed in two ways. First, by buying well. Hopefully, that helps you with the second part of inventory risk management- selling well. My last article for Canadian Snowboard Business actually talked about that. Maybe they’ve put it up on their web site and could put the link HERE? I’ve also written about using a concept called Gross Margin Return on Inventory Investment (GMROII) as a tool to increase your gross profit dollars and, incidentally, reduce your inventory risk and you can see that on my web site here.
You can never get rid of inventory risk, but if you’re buying well and using GMROII, you’ve probably done everything you can reasonably do to minimize it.
Who’s Inventory Risk?
It’s impossible to completely eliminate inventory risk and be in business. In a perfect world, a retailer would love it if the brand could give them only the stock they need to merchandise their store and then have replenishments show up over night. Oh- and they’d prefer it if everything they got was on consignment. The brand, sitting on the other side of the equation, wants the store to buy everything all at once and pay cash in advance. Obviously neither is going to get their way.
The original premise behind this article was that inventory risk was a zero sum game. That is, it existed and somebody- the retailer, the brand, or the manufacturer- had to shoulder it. Zero sum means that you can pass it around, but not reduce or eliminate it. The only question is who takes the risk.
I’m not so sure that’s completely true. After some thought, and some conversations with some smart people, I’m beginning to look at inventory risk as an indivisible part of systemic business risk. You can manage it, but it’s just not independent of overall business conditions and your relationship with your customer or buyer. It’s not zero sum because you can work together to reduce it.
Some Real Life Examples
Jeff Logosz is the cofounder and CEO of ten year old Slingshot Sports. It’s a leader in kiteboarding and has recently launched into wake boarding. He points out that until recently the action sports business model has been to incentivize retailers, through terms, discounts and other forms of support,o to place a larger preseason order than they otherwise would or should, thereby transferring the inventory risk to the retailer. But that mdel, based on an assumption of higher growth, is failing in a weak economy because it doesn’t begin with realistically estimating true demand.
“One you find the demand line and are honest about it, and start producing under it, you really start building your brand,” Jeff says.
And of course both the retailer and the brand reduce their inventory risk because they aren’t kidding themselves about demand. You can see where I’m going with this. Good demand planning at all levels of the supply chain can reduce the inventory risk for everybody- not just transfer it from one player to the other.
Sanction is a snowboard and skate retailer with shops in North Toronto and the Kitchener/Waterloo area. Co-owner Charles Javier says he dropped a lot of the larger snow related brands or lowered the quantity he bought this year. He’s been bringing in smaller brands, and does better with them than with some of the larger ones. In fact, they upped their total buy this year. “How we manage inventory risk isn’t about how we put risk off on the brand, but about how we buy,” he told me.
And he’s not particularly concerned that his smaller preseason orders with some brands will keep him from having enough product later in the season. “There’s always going to be inventory available,” he said.
A consistent theme in my conversations has been brands warning that they aren’t making product much beyond orders, and that retailers who want it better have gotten their orders in, and retailers not quite believing them, or not quite caring, or thinking they could substitute another brand. I guess by the time you read this, we’ll know how it worked out. I hope to hell there are some product shortages that make some of this stuff a bit scarce and special again.
Darren Hawrish is the president and owner of No Limits Distribution. Located in Vancouver, it handles Sessions, Reef, Osiris, Capita, Union and other brands in Canada. He and Charles at Sanction would probably get along just fine, as Darren, like Charles think you manage your inventory risk by how you buy. He’s been more diligent on inventory this year, looking at it weekly instead of monthly.
“Inventory is the make or break part of your business,” he told me. “You can’t increase sales [which they expect to do, though not as much as in previous years] without it.” But posted on their walls is a sign that says, “Inventory Is Death” so it seems they have a healthy balance in how they handle it. “The discount doesn’t matter if you can’t sell it,” he reminded me.
He’s seeing tightness all along the supply chain. He thinks it’s a lot tougher to make in season buys than it was 18 months ago or so. His goal is to sell what he gets in. On the face of it, that sounds kind of obvious. But in his mind inventory and buying are closely tied to having clearly defined growth and margin goals, so there is a strategic component to inventory that a lot of people may not be thinking about. And that is another way that Darren works to reduce inventory risk.
I’m not quite sure the musical chairs analogy I used in the title holds up. Inventory risk can’t be isolated from general business risk, and it’s not a known quantity that just gets passed around. A brand that sells its product and gets paid for it still hasn’t eliminated its inventory risk. What happens when all that inventory doesn’t sell and the retailer has to dump it? What’s the impact if they go out of business and aren’t around to buy anything next year? What if the value of the retailer’s inventory goes to hell because of the distribution actions of the brand? What’s the brand suppose to do when a retailer grey markets stuff outside of normal distribution channels? Seems to me that inventory risk exists all across the supply channel and we’re all in it together.
It gets minimized when the sales plan is realistic and consistent with the brand or retailer’s market position and strategic goals. Not to mention market conditions. It is further minimized when you buy based on your best estimate of demand regardless of terms, discounts and or other incentives.
Current economic conditions are requiring us to reduce our inventory risk and to pay closer attention to all the management accounting and operations management things that, frankly, aren’t much fun. But we’ll be a much better run industry as a result and might even bring back to at least some of our product the sense of exclusivity it has lost over time.
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