May 2006 | Commentary | Checking In

Less is Less and Less is More

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Two important trends will impact your warehouse operations in the near term.

First, retailers will seek to trim inventory even further to increase profits without reducing customer service standards. Wal-Mart, for example, recently announced its intention to cut $6.5 billion in inventory off an already lean 2:1 inventory-to-sales ratio.

The goal? "Theoretical Zero Inventory." The retailer won't own any inventory until they sell it. Sounds ambitious. Let's take a look.

GMROI (gross margin return on inventory) principles have guided retailers' success for decades. Here's an example. Say a retailer marks up an item by 18 percent. It will need at least six inventory turns to make any money (0.18 x 6 = $1.08). For every dollar invested in that item the retailer needs six turns to capture its investment back and earn eight cents.

Of course eight cents isn't that much. If the retailer wanted to make a buck on its original dollar of investment on that item, it would have to turn it 11 times.

With Wal-Mart's pronouncement, the GMROI calculation gets marginalized (pun intended) because the company is not investing in the actual inventory—its suppliers are. As Wal-Mart goes, so goes retailing.

And as retailing goes, so goes the nation. CVS and other retailers have already indicated they, too, are moving toward the aggressive Theoretical Zero Inventory model. Analysts speaking to large Wal-Mart suppliers, such as Procter & Gamble and Spectrum Brands, report pressure of another kind from the folks in Bentonville: fewer product lines. If this is true, it brings us to the second trend.

"Choice-crazy consumers are now making endless demands on modern warehouses and logistics," according to the new book Warehouses: Witnesses of Prosperity, published by Lannoo. "With 40,000 different products in each supermarket, the current warehouse is threatened from within: it staggers under the whims of the exacting customer."

Whether you agree with that or not, there is growing pressure for less product diversity and fewer SKUs because inventory complexity increases costs. This strategy pits marketeers against bean counters. Here's why.

SKU creep—where products sold seemingly multiply before your eyes—is driven by marketing and sales. The age-old question—"Is it about cutting costs or selling more?"—creates tension between those striving to get the efficiencies simplicity provides and those wanting to increase sales and market share, serve customers better, and generate the revenue those complexities create.

Want a perfect illustration of this tension? Let's view the two trends through the Wal-Mart looking glass. At almost the same time Wal-Mart announced the Theoretical Zero Inventory approach, it announced it wants more upscale customers.

Well, unless Wal-Mart is abandoning its base—low-cost shoppers—those low-cost SKUs will remain. To attract new shoppers, the retailer will have to add new products for those "choice-crazy consumers." There goes SKU creep.

So Theoretical Zero Inventory proponents converge with SKU cutters. Where's the action at? Why, at a warehouse near you!

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